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Inflation reached 7.5% and interest on 10-year government bonds went from 1.4% to 1.8% in January, while the 15-year mortgage rate was 3.2% and the four-year auto loan rate was 3.5% that same month. Those rates (as well as corporate bond rates) are negative real rates because they are lower than inflation. Banks pay low negative real interest rates (lower than inflation) to the Fed and to their depositors, so they capture funds to lend at somewhat higher interest rates, but still below inflation, and make a profit as intermediaries on the difference between those two negative real rates.
But when the Fed announced a future tighter monetary policy and stock market indexes fell in January, the scenario became unstable.
Although the S&P 500 fell 5.5% in January, it had risen 27% in the previous 12 months. Few companies would actually change their plans because the borrowing rate rises from 3% to 4%. A nominal interest rate of 4% would be high only if price inflation were to fall significantly, something no one expects with monetary policy as it is now.
After falling by 3.4% in 2020, the American GDP grew by 5.7% in 2021. The International Monetary Fund (IMF) predicts a 4% growth in 2022. But while government spending and debt are breaking records, private fixed capital investment is growing little and slowly.
Real wages have been falling for months due to the weak demand for labor. The effects of previous discretionary and prolonged shutdowns of economies on the delicate capital structure will be followed by bottlenecks, so that production capacity will fail to meet demands.
As long as the Fed’s monetary discipline is purely rhetorical, maintaining cheap credit to avoid politically costly adjustments for the administration, stagflation will be an increasingly possible future scenario.
For now and with cheap credit growth prospects of 4% or more in 2022 will continue to look good in the short term, because the bond market will not offer attractive alternatives. As long as the Fed refrains from raising interest rates to positive rates in real terms, investors will continue to buy stocks, especially after occasional profit-taking like the one in January. If inflation drops a few fractions of a point, investors and bankers will anticipate a generous response from the Fed.
The U.S. economy cannot move toward healthy productive growth because, during the shutdowns caused by the Covid-19 emergency, spending grew too much along with debt and regulatory and fiscal pressures. The current low growth is entirely dependent on inflation and cheap credit. A readjustment of the accumulated distortions in the economy would necessarily require a recession, but the Biden administration decided to maintain and increase fiscal and regulatory pressures by betting on cheap credit, regardless of inflation, because it aspires to “grow” with its big green bubble of subsidies and speculation.
Even if a restrictive monetary policy were adopted now, without a drop in fiscal pressure and deep deregulation, it would take years to absorb the consequences of monetary manipulation and bring public debt down to sustainable levels. Currently, a good number of companies are overvalued because investors bet on rent capture by high-tech and “clean” energy corporations politically close to Washington. Those companies and those directly and indirectly dependent on them will fall if credit conditions tighten or investors panic for any reason.
In the short term, everything indicates that those who believe that the Fed’s announcements of tight monetary policy are not yet serious are right. If we see a moderate slowdown and rates remain negative, the party will go on for a few quarters waiting for a new bubble to extend further. Until finally the need to control inflation by tightening credit sheds light on the accumulation of investment errors throughout the economy, and a recession – which will be worse the longer it is artificially delayed – corrects the misalignments to allow for a new and reasonably healthy growth.
Guillermo Rodríguez is a professor of Political Economy in the extension area of the Faculty of Economic and Administrative Sciences at Universidad Monteávila, in Caracas. A researcher at the Juan de Mariana Center and author of several books // Guillermo es profesor de Economía Política en el área de extensión de la Facultad de Ciencias Económicas y Administrativas de la Universidad Monteávila, en Caracas, investigador en el Centro Juan de Mariana y autor de varios libros