Research Summary
The report discusses the impact of higher interest rates on the economy, particularly in the aftermath of the COVID-19 pandemic. It highlights the shift from near-zero interest rates to more “normal” levels above 5%, and the potential lagged impact of this monetary tightening. The report also explores the 2023 banking crisis in the United States, the decline in demand for new loans, and the contraction in the money supply. It concludes with a discussion on the unsustainable nature of current government debt and the potential economic repercussions.
Key Takeaways
Return to “Normal” Interest Rates
- Historical Shift: The report notes a significant shift from near-zero interest rates, prevalent for 14 years, to more “normal” levels above 5%. This shift was initially deemed impossible due to the economy’s dependency on low rates.
- Monetary Tightening: Despite the seemingly smooth transition, the report suggests a lagged impact of this monetary tightening, which could potentially hit the economy hard in the future.
- Stubborn View: The authors maintain their initial view that the economy is heading into a period of economic pain due to the inappropriate near-zero interest rates that prevailed for 14 years.
2023 Banking Crisis
- Bank Failures: The report mentions a banking crisis in the United States in 2023, resulting in the failure of several banks. This crisis was attributed to years of low interest rates and the subsequent aggressive rate increases.
- Resolved Crisis: Despite the crisis, the situation appears resolved and the magnitude of the crisis was minimal, suggesting that the impact of the monetary policy shift was not as severe as anticipated.
- Interest Rates as Culprit: The authors argue that the primary cause of the crisis was the interest rates, not the “Operation Chokepoint 2.0” campaign against the cryptocurrency industry.
Decline in Demand for New Loans
- Reluctance to Borrow: The report notes that corporates and consumers are increasingly reluctant to take on new loans at higher rates, leading to a significant decline in demand for new loans.
- Record Low Demand: According to the July 2023 Federal Reserve Senior Loan Officer survey, demand for industrial and commercial loans is at its lowest level since the 2008 financial crisis.
- Eventual Credit Contraction: The authors predict an inevitable credit contraction as the impact of higher rates starts to be felt in various areas of the economy.
Contraction in Money Supply
- Decline in M1 and M2: The report highlights a contraction in the money supply, with M1 in the United States declining by 10.6% and M2 falling by 3.9% from its peak.
- Unprecedented Decline: This is the first decline in M2 since 1949, a phenomenon so unprecedented that economists are unsure of its implications for economic growth.
- Impact on Financial Conditions: The declining M2 represents a tightening in financial conditions and illustrates the scale of the tightening, which is of a magnitude not seen before.
Unsustainable Government Debt
- High Interest Costs: The report points out that the current United States government debt stands at US$32.3 trillion, implying an annual interest cost of around US$1.5 trillion, which may be politically unsustainable.
- Economic Time Bomb: The authors suggest that such high interest costs represent an obvious ticking economic time bomb.
Actionable Insights
- Anticipate the Lagged Impact: Stakeholders should prepare for the potential lagged impact of the monetary tightening, which could hit the economy hard in the future.
- Monitor Loan Demand: The decline in demand for new loans could lead to an eventual credit contraction, affecting various sectors of the economy. Monitoring this trend could provide early warning signs of economic distress.
- Assess the Impact of Money Supply Contraction: The unprecedented contraction in the money supply could have significant implications for economic growth. Stakeholders should assess the potential impact of this contraction on their operations and investments.
