You might not hear many people talking about the return of inflation right now. Richard Sylla says that doesn’t mean inflation isn’t coming. The NYU professor and co-author of A History of Interest Rates joined Jim Puplava on a recent edition of the Financial Sense Newshour podcast where they discussed the return of inflation, ultra-low interest rates, MMT and the financial impacts from the coronavirus.
How would you describe the world of interest rates we find ourselves in today?
Well, I think it's unprecedented. We are seeing the lowest interest rates in recorded human history. At the peak in 1981, we had 15% on government bonds and 20% on bank loans. It’s been almost 40 years since we had the highest interest rates in U.S. history.
Now, four decades later, we've seen the lowest rates in U.S. history and all around the world. Our rates have briefly been negative, but Europe and Japan have seen negative rates for some time. In fact, there's a huge amount of debt. I've seen estimates of $10 to $15 trillion of debt and mostly European bonds, probably sovereign bonds, that are showing negative rates.
So, this is unprecedented and one of the themes of our book, of course, is that there are cycles of interest rates – they trend down for a while they trend up for a while. We've been trending down for 39 years. And that's kind of outside the limits. Usually they reverse around three to four decades after they've been trending one way. I'm wondering whether that historical pattern will hold.
Is there any relation between how high or low interest rates are and the amount of debt in the economy?
I think there is a relationship, obviously, because the government is borrowing a lot of money to finance its deficits. I think the nearest analogy might be to wartime. The governments borrow a lot of money in wars and you know, people are referring to the coronavirus as a war of sorts. I think President Trump calls the virus an invisible enemy. And, in terms of what's going on now, it is like a war. We have massive increases in government spending, plus, we're removing some of our workers from the labor force. So, it’s like they're going in the army. I mean, we're doing that in a massive way when we shut down restaurants and hotels and cruise lines. That's causing a lot of people to leave the labor force.
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One of the lessons of history is that in wartime we have these great demands and production that’s either altered or moved to other types of activity. Both things typically result in inflation. I haven't heard many people talking about it yet, but I've studied the history of U.S. wars and we almost had a hyperinflation during the American Revolution. We had an inflation during the war of 1812, and in the Civil War the price level doubled from 1861 to 1864. During WWI the price level doubled, and the price level doubled after WWII when they took the price control off.
If we're going to war with the virus now, I think investors and historians should be thinking about the fact that, usually, when you have wars there are inflationary pressures. And we need to consider what impact that will have on interest rates.
If prices start to go up, people who lend money will want to have some protection for what they lend and maybe, the bond vigilantes from the 1990s return. They disappeared because we got inflation down to low levels. You know, the Federal Reserve has been apologizing for not meeting its 2% target, despite all its efforts and trouble it had getting up to that target. I think the bond market vigilantes said well, the Fed has got a pretty low inflation target and they can't even reach that. So we don't have to worry that much about inflation. That seems to have been true for the last couple of decades, maybe three decades now.
So, the bond market vigilantes went into hibernation, but they may come back now that we're fighting a war against a virus with massive increases in government spending and that’s taking some of our workers away from their jobs. Most all other wars we had resulted in some inflation. I have a feeling in my bones that we'll see some of that inflationary pressure as well.
If we were to normalize and get interest rates back to 4% or even 5%, that could be a lot of money added to the federal deficit when you're talking about $24 to $30 trillion in debt.
That's certainly true. And those rates you mentioned seem far off in the distant past. But, I remember when I was a young man in the late 1950s and 1960s, you would get 4% interest on a government bond. Of course, rates moved up from there, going into the inflation of the 70s. It's going to strain the government's budget.
One of the reasons I worry about inflation, maybe more than most people, is that it would be in the interest of the government for the debt obligations to have some inflation. In the 70s in California, they talked about bracket creep— the people were paying more in taxes because we have a progressive tax system, but they weren't getting gains in real income. They were just having their incomes marked up by inflation. We may be in for a period like that again. If you can make analogies with history, there's some chance that we will tolerate inflation because it's in the interests of debtors to have inflation. And the government is going to be, even more than it is now, the biggest debtor of all.
Read Zero-Bound: The Return of Inflation and the Loss of Income for Jim Puplava's thoughts on inflation.
Modern Monetary Theory (MMT) basically says if you can issue debt in your own currency, you don't have to worry about default. And, you can always control inflation through taxation. There seems to be a justification right now to inflate and the Fed will just monetize it.
That’s right. MMT is basically money printing. I think they make a valid point; the Fed's balance sheet has gone from a little over $4 trillion up to $6 trillion in the last month or two. Now that we're not on a gold standard, the Fed is under no obligation to convert its paper promises—our currency—into any hard metal. So freed from that constraint, the Fed does have the sort of powers that MMT says they have. The question is, what will be the results of these policies of money printing?
MMT says you can mop it up with higher taxes. I've lived a long time and I've seen that when you start talking about raising taxes, especially if you need to do it quickly to stop an inflationary bubble from being created, it just doesn’t work that way. There'll be a lot of opposition to any tax increases.
I think, MMT is a little bit Goldilocks or Pollyannaish when it thinks it's so easy to stop any inflation through fiscal measures. It's more likely that the inflation will get away from us. And, again, I want to reiterate that inflation is in the interest of a lot of people, like debtors.
How would you position for something like this? Because it seems like inflation is far from the minds of investors and the market.
You know, that's right. I've even heard people say that the effect of this crisis may be deflationary in the sense that we're shutting down a lot of productive facilities now. When we come back on stream, people will be slow to go out and resume their normal ways of shopping. And yet, the businesses will be able to make a lot of products. So, some people say the only way they'll be able to move their products will be to cut the prices. I think consumers will come back as fast as business starts producing again.
I don't really worry about that deflationary aspect of it, but I think we do have to worry about the inflationary aspect of it. I'm surprised that more people aren't talking about that now. It may be that they just haven't studied the history of the wars in U.S. history like I have, and they haven't had any inflation to speak of for 25 or 30 years.
We've gotten used to having a low level of inflation. That doesn't mean it can never come back. Before 2007, we hadn't had a major financial crisis since the 1930s, but then we had a major financial crisis. So just because we've gotten used to something for two or three decades doesn't mean that something else might not be right around the corner.
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