If Lacy Hunt was into making bumper sticker-style sound bites, his would be a riff on James Carville’s “It’s the economy, stupid.”
The Hunt sound bite would simply say: “It’s the debt, stupid.”
But Dr. Hunt, the economist at Hoisington Investment Management, an Austin, Texas, fixed-income asset management firm, isn’t into sound bites. Instead, he’s a meticulous data collector who has been telling clients, year after year, that interest rates were headed down. Those who doubted or bet against him, thinking interest rates couldn’t possibly go lower, lost money.
The reason this is happening, he argues, is that we’re in a long-term slump due to massive over-indebtedness. We’ve simply got too much debt for the economy to return to normal growth. Worse, none of the usual policy fixes — such as debt-funded government spending — will work.
So people look for answers to some vexing questions. Like, if debt is the problem, what is the solution?
Or: Yes, but what about the positive signs like housing and car sales?
Or: How long can this low interest rate siege last?
Borrowers will love his answer to the last question. Savers will be troubled. Flipping through one of his chart collections, Hunt comes to a chart that overlays the history of interest rate declines after major financial panics. If the future replays such past events, it takes about 14 years for interest rates to hit bottom. Since our last financial debacle was in 2008, that suggests interest rates might continue falling until 2022. Yes, savers, you read that right: 2022.
And when that happens, the same data shows that long-term government bond yields will bottom at about 2 percent, compared to their current rate of 2.9 percent. Even 20 years after financial disasters like 2008, interest rates are only about 2.5 percent.
Savers are facing a yield famine that could last beyond 2028. And borrowers who just refinanced their homes at 3.5 percent might have yet another opportunity to reduce their mortgage payment.
What about the signs of recovery in auto sales and housing?
He shakes his head. Probably not sustainable, he suggests. “Student loan debt keeps rising. Real household income continues to decline. It doesn’t work if you add jobs that pay $20,000 to $40,000, but you lose jobs that pay $70,000.
“The median household income has declined more over the three-year expansion than it did during the recession,” he points out. “Median household income is down from 1997 and unchanged from 1995.”
Is there a government policy solution?
Not much hope there, he observes. “The Federal Reserve has really been on the wrong course for a long time. It started with the response to the [savings and loan] crisis in the early ’90s, then the long-term capital crisis, the failure to regulate the growth of mortgage debt after 1995 and all three quantitative easings — all involved liquidity injections and reduced interest rates. And it is continuing now.
“The argument is that if you have gains in the housing and equity markets [induced by low interest rates], you’ll stimulate consumption. But it really depends on who has the higher propensity to spend out of income, savers or debtors. Remember, the income of one is going up and the income of the other is going down.
“Another problem with additional debt is that it’s likely to be the wrong kind of debt — debt that won’t generate enough income to repay itself. ... The process of building this massive debt takes a long time, and in the buildup there is a persistent erosion of economic capability.”
As a consequence, he points out, the favored response from Washington is likely to make our economic problems worse, not better, because the only “cure” is time — time for the burden of debt to decline.
But what happens, I ask, if debt just continues to climb?
“At some point, a government will exhaust every avenue for obtaining new credit,” he said.
Hunt then gives me a modern vocabulary lesson. He notes that the limits of government borrowing are such a big part of current discussion that we’ve now got four different phrases for talking about the same event:
• “The fiscal limit” (the least scary, most polite description);
• “The Keynesian Endgame,” which references the end of an idea about the role of government that has dominated economics for more than 75 years;
• “The John Cochrane Condition,” which references an important but little known paper;
• And finally, the dramatic: “Bang Point.” That’s when lenders will say to all the big borrowing governments, including ours: “In God we trust. All others pay cash.”
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