There’s fear in the credit and public debt markets but for me, personally, looking at the deep end of the long-dated treasuries and public debt notes in Europe, there are good bargains to be found. We have come a long way ever since Jay Powell said “We are not thinking of thinking of raising rates”, to “inflation is transitory” and finally to “higher for longer”. In just three years we have been through one of the most volatile and dynamic periods in financial and economic history: from the collapse of the ten-year bull market with the Covid crash to the renewed bull market pushed by the Fed’s easy monetary policy, and now, the sour conclusion of monetary tightening and high-interest rates. The party is over, but is it?
Some are calling for the end of the low-interest rate cycle”. “Higher for longer” means that a new age of monetary policy has begun and we will never again see 0 rates. Yet, I suspect, that once again, the crowd is doing the same mistake it always does. Michael Saylor candidly admitted being on the wrong side of the trade when he was buying bitcoin on debt at exorbitant prices saying that he took Powell’s words, back then, literally. “It didn’t turn out that way” Saylor admits as he is left with a bag of bitcoin on debt whilst being down on his investment by around $ 2 billion. Markets punish the stupidity of crowds and this stupidity is often the fixation with the present that things will ever more remain the same or at least similar. It is the same mistake people do in politics and other spheres. No one expects history in the same fashion no one expects the Spanish Inquisition.
As for “higher for longer” history tells us something different, and even here we see the crowd fixating on the present. Indeed, history tells us the opposite of what Powell is telling us because, in fact, historically, interest rates tend to go down perpetually. In other words, history doesn’t show that we have been in a low interest cycle, but rather we are in long-term secular trend of easing interest rates and monetary policy.
So, as we can see, with the first chart of the Fed’s interest rate and the rest of the charts on the yield of government debt, it is undoubtedly clear that throughout the last century, debt has consistently become cheaper. Is this a phenomenon unique to the 20th century which spilt over into the 21st century? No, it is not. Throughout history, debt has consistently become cheaper and debt was, in fact, one of the many economic features in Late Medieval Europe which enabled the growth of capitalism with initially, debt going at incredibly high prices. In this beautifully laid out study, Paul Schmelzing shows how interest rates have gone down on a secular downtrend trend ever since debt proliferated in Late Medieval Europe. And clearly, in history, there is a strong correlation between low-interest rates and the proliferation of debt. The global economy is dependent on an ever-increasing amount of debt, and the lowering cost of debt is happening along with its increasing proliferation.
This chart hardly looks like a cycle as opposed to a long-term global secular trend. And clearly, one can see the red part, representing emerging economies growing ever bigger and considering the huge number of people yet to come out of poverty in many parts of the world, there’s a very high probability that the red part is going to keep growing with economic development in emerging economies. Will the blue part go down? The logical expectation would be that given that we are entering into a quantitative tightening phase with a “higher for longer” rates regime, the blue part will once again be going down again. Supposedly, some would say that negative interest rates were a temporary phenomenon of the Covid pandemic whereas an economic lockdown required central banks to excessively pump liquidity into the system, but even this kind of thinking is loaded with the assumption that we are clear, at least in the medium term of further crises which will require once again massive amounts of new liquidity from central banks and increased fiscal spending.
Unfortunately, I could not find charts of historical global debt but there are plenty of historiographic sources which delineate how throughout history every major historical advancement or event was supported or featured some sort of debt. See, for example, A World of Public Debts: A political history, (edited by Nicolas Barreyre and Nicolas Delalande). Wars and campaigns of conquest and discovery were funded by debt and so was the Spanish Empire which eventually fell on its own weight. In order to fight the Napoleonic Wars, the British government had to take so much debt that it could only pay it in full around 100 years later, only to indebt itself once again with the event of the First World War. Eventually, as the United States surpassed Britain in global superpower status, the global debt burden shifted to the US. As for private citizens, debt has always been common too. In his seminal work, 5,000 years of debt, David Graeber writes that most of the town-dwellers of a typical English Medieval town bought most of their stuff on credit with money in circulation being very rare.
In principle, debt is the means to wealth and we can see in history that this truth holds up very well. There is historically some sort of ongoing and direct relationship between the amount of debt the world holds and the amount of wealth that exists. After all, logically, if there is a debtor there is a creditor and theoretically, someone is making money from that debt. So, it also makes sense that the exponential proliferation of debt started alongside the rise of capitalism and the industrial revolution in Britain in the 18th century with the arrival of the banknote. Thanks to the banknote, banks could literally create money out of thin air. The banking boom of the 18th century which lead to what we today call “money printing” later on in the next century, financed the industrial revolution in Britain and modern capitalism.
Today, more than two hundred years later after Nathan Rothschild made his infamous gilt trade, where he was one of the first to massively buy government gilts after the Wellington and Blucher defeated Napoleon at the Battle of Waterloo, a few kilometres away from today’s Brussels, the world’s debt seems equally insurmountable. And yet, at a 200% debt-to-GDP ratio, Rothschild’s bet on the British Pound was also political. With France’s defeat assured and Napoleon incarcerated in Saint Helena, Britain’s absolute and global dominance was secured and the British Pound was to reign supreme. Even at those levels, Britain’s debt was insignificant to the vast amount of economic power that it could exercise abroad. Nathan Rothschild ended up being right. The British Pound was to remain the world’s leading currency well into the early 20th century.
Fast-forward to this year and the US, the biggest economy and the world’s superpower looks at face value to have an insurmountable amount of debt, yet if history serves as a guide, the US, with a debt-to-GDP ratio of 125% doesn’t seem to be at a historical extreme by British standards. In today’s extreme we have Japan with a debt-to-GDP ratio of 263%, undoubtedly one of the highest ever recorded in history for an advanced economy. And Japan doesn’t seem to be letting go of its easy monetary policy either. There is neither any sign that policymakers in the US will ever start reducing government spending. If the debt-to-GDP ratio is too close in the US, it seems that policymakers will only ever allow it to close if the economy grows even bigger and the government adds even more revenue.
So, one could ask the question, where is the breaking point? Where is the point where so much debt for the US becomes unsustainable? The answer to that question may not lie in complex arithmetic models, but it may simply be political, that is, the US government can keep increasing its debt as long as there is demand for it, and for there to be demand for US Dollar, the US has to keep doing what is doing right now and keep being the world’s superpower. Sounds simple, but often the most simple answers are correct. Yet, there is some sort of balance between the political reality of the global supremacy of the Dollar and the US government’s debt at home. This balance I suppose is kept by allowing interest rates at sustainable rates enough for the government to be able to service this debt without going into a crisis. And as debt increases, the interest rate has to be ever lower.
That leaves us with ever-growing debt, a money supply that never stops growing and undoubtedly, growing economies. Markets will follow or lead, whichever way you want to interpret it. History is telling us that capitalism will give us more of the same. Interest rates will go down again, debt will increase and the global economy will continue to grow. We are nowhere near at a point where the US Dollar will lose its supremacy, and if anything these are only its early stages of dominance. Judging by history, global superpowers often had long stretches of historical dominance lasting centuries. The US only became the world’s leading superpower last century and we only have just started this one.
There is much more which should be discussed in such a debate, but for tonight I am calling it a day. Next time I would like to discuss the 1970s and how its inflationary environment compares with today. Another very important aspect which should be discussed in this debate is the distribution of wealth and how easy monetary policy has most probably helped induce today’s current housing crises.