Opinion | Is the Era of Cheap Money Over?

Interest rates are rising. Stocks, especially glamorous stocks, like Tesla, are down. And the crypto crash was truly epic. What’s going on?

Well, many people I’ve read have offered an overarching narrative that goes something like this: For the past 10 or maybe even 20 years, the Fed has kept interest rates artificially low. These low rates inflated bubbles everywhere, as investors desperately searched for something that would give a decent rate of return. And now the era of cheap money is over and nothing will be the same.

You can see the appeal of this narrative; it ties everything together into one story. Yet, to paraphrase HL Mencken, there is always a well-known explanation for every economic problem – neat, plausible and false. No, interest rates were not artificially low; no, they did not cause the bubbles; no, the era of cheap money is probably not over.

Let’s start with these interest rates. Here is a graph of the real interest rate – the interest rate minus the expected inflation rate – on 10-year US government bonds since the 1960s. (I used the average inflation rate, at excluding food and energy prices, over the previous three years to represent expected inflation; good enough for present purposes.) There was indeed a huge drop in real rates after 2000 :

But was this decline “artificial”? What would that even mean? Short-term interest rates are set by the Federal Reserve and long-term rates reflect expected future short-term rates. There is no interest rate unaffected by the policy. There is, however, what economists have long called the “natural rate of interest”: the rate of interest consistent with price stability, neither high enough to cause depression nor low enough to cause excessive inflation.

So, was the claim that the Fed consistently set interest below this natural rate? If so, where was the runaway inflation? In fact, until 2021, inflation has consistently more or less met the Fed’s target of 2% per year.

But why was the natural rate so low? The immediate answer is that the Fed learned from experience that it needed to keep rates low to keep the economy from sliding into recession. I’ll get to the deeper answers in a minute. But if you think the Fed set rates too low throughout this period, you’re really saying the Fed should have deliberately kept the economy depressed in order to avoid… something.

The usual explanation goes along these lines: “Maybe the prices of goods and services haven’t skyrocketed, but look at all those asset bubbles!” And there were big bubbles in the era of low interest rates. There was the great housing bubble of the mid-2000s, which paved the way for the global financial crisis. We then had what was quite clearly a stock of crypto-memes-Elon Musk-Bored Apes-etc. bubble.

However, if you want to say that low interest rates were responsible for these bubbles, you have to accept the fact that there were other impressive bubbles before rates fell.

I suspect – I hope! – that some of my readers are too young to remember how intense the hype around tech stocks was in the late 1990s. (Kids, get off my lawn!) The video in the next section was an advertisement particularly memorable from telecommunications company Qwest, heralding the coming wonders of high-speed internet – which, contrary to what I expected from the promised wonders of crypto, actually materialized. These days, you can indeed watch nearly every movie ever made, from “Gold Diggers of 1933” to “Plan 9 from Outer Space,” from your filthy motel room.

Incidentally, this ad was unintentionally accurate in another way: a dirty motel room with unlimited streaming is still a dirty motel room. Information technology is amazing, but it has done far less than many hoped to improve our material quality of life.

Going back to my current point, while the computer revolution was real, it did not justify the prices people were paying for tech stocks. Here’s what happened to the Nasdaq at the time:

And Qwest, which ran these clever ads, took a particularly hard fall. Its market value has evaporated; its CEO was eventually convicted of insider trading.

But there’s the problem: If you go back to my first chart, you’ll see that the tech bubble, with all its crazy valuations and fraud, took place at a time when real interest rates were quite high relative to historic standards, and far higher than they have been recently. In other words, bubbles, even wild bubbles inflated in part by fraud, can occur even when the Fed has failed to keep interest rates low to support a weak broader economy.

Yet interest rates have risen significantly in recent months. Does this mean that the era of cheap money is over? To answer that question, you have to ask yourself why the Fed felt compelled to keep rates so low for so long.

The basic answer is that since 2000, and especially since the global financial crisis, corporations have consistently refused to maintain a level of capital expenditure that used up all the money that households wanted to save, unless interest rates are very low. This condition goes by the unfortunate name of “secular stagnation” – unfortunate because it is widely and erroneously interpreted as a statement that it means slow growth, not low interest rates. The idea of ​​secular stagnation was first introduced in the 1930s, but the post-war boom made it seem irrelevant. Then Japan began to experience persistent weakness and very low interest rates in the 1990s, and in the aftermath of the 2008 financial crisis, the entire advanced world found itself in a similar situation.

What causes secular stagnation? The best guess is that a lot of it is demographics. When the working-age population is slowly growing or even shrinking, there is much less need for new office parks, shopping malls, or even housing, hence low demand. And as you can see from this graph, America’s working-age population, which had been growing rapidly for many decades, began to stagnate just as interest rates began to fall:

And these demographic forces are not going away. On the contrary, they are likely to intensify, in part because the rate of immigration has fallen. There is therefore every reason to believe that we will soon return to an era of low interest rates.

In this case, however, why have rates skyrocketed? Well, the Fed is raising rates right now to fight inflation. But that’s probably temporary: once inflation drops to 2-3%, which will likely happen by the end of next year, the Fed will start cutting again. In fact, real long-term interest rates, which reflect expectations of future Fed policy, are up from their pandemic lows, but still around where they were in 2018-19. . In other words, the market is effectively betting that the era of cheap money will return.

Does this mean there will be more bubbles in our future? Yes, but there would be more bubbles even if interest rates remained high. The hype is eternal.


If you ask me, the bubble of the 1990s produced better ads.


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