Seat belt. The next president will inherit an economy defined by conditions that we have never seen in our lives.
Let’s take stock. For starters, the Federal Reserve has embarked on a bold strategy, never before tested, to recharge the COVID-stricken economy and support the prices of everything from stocks to houses. The Fed’s plan focuses on keeping interest rates short-term and possibly a long stretch of the yield curve below the level of inflation. Super cheap loans, the Fed acknowledges, will entice companies to invest in new plants and factories, boosting productivity and growth, and backing assets that may not yield much, but would outperform Treasuries by such a wide margin. that they would maintain their high valuations. .
The Fed’s stance is winning widespread praise from Wall Street and American businesses. But it also raises a persistent problem: Interest rates, left to the market, generally provide investors with a return that exceeds the trend in overall prices, often by far. That makes sense. Large lenders, such as banks and hedge funds, and people who buy corporate bonds, want interest payments that are well above the current inflation rate, even on the safest loans, as payment (an added cushion ) to immobilize your money for years and risk. . . . future unforeseen increases in consumer and producer prices wipe out their profits.
For decades, companies have voluntarily paid various points on inflation because they can earn much more by using that money to build or renovate factories or launch new winning products.
Now the Fed is buying such a gigantic share of all newly issued government and private bonds that it is constantly increasing their prices. Those super-high prices have lowered the pennies of interest that investors charge for every dollar they pay in bonds to lows never before seen in modern American history. So the consumer price index is now rising faster than the Treasury yield, with the best-rated corporate bonds offering 2.3%, outpacing inflation by less than one point.
So it’s logical to worry that by creating a major distortion in credit markets, the Fed could unleash a backlash from another bastion of the economy that is hit by artificially low rates. By pulling hard on the stimulus lever, will the Fed push another set of macroeconomic forces that are headed in the wrong direction, undermining growth and hurting asset prices?
Alankar thinks a hay farmer is making a fist and could attack at any moment. As foreigners recede, he says, Americans will be forced to fill the gap by investing trillions of their savings in Treasuries. All these savings available to companies would be reduced. It’s unclear what effect such a shortage would have on future rates, because the Fed could take more extraordinary steps to keep its benchmark artificially low, a stance that could depress yields on all bonds. In any event, government loans would “crowd out” much of the private capital needed to finance new growth, while a fall in the dollar fuels inflation. Result: stagflation reminiscent of that of the United States in the 1970s and Japan for more than two decades.
But another result is also possible. The dollar’s slide could become so severe that the Fed will raise its hand and raise rates to fight inflation and boost the dollar. Of course, the stock market freaks out at the sign of higher rates, and the adjustment would push the United States into another recession. But the market, not the Fed, would be in charge again. And the foreign investors we so desperately need would be returning in droves to America’s safe haven, which is not only the safest in the world, but also free to deliver a decent return once again.
