Low-returns capitalism

There was a long-wave cycle of a little over forty years where interest rates rose fairly consistently from the 1930s to about 1980.

Longer-term rates (of corporate bonds, municipal bonds, etc.) are based on the 10-year treasury bond. Its yield in 1981 was around 14%. Shorter-term rates are based on the federal funds rate. In 1981 it was about 16%.

Then there was a long-wave cycle of about forty years where interest rates fell fairly consistently from 1981 to 2020.

The 10-year treasury bond now yields under 1% and the federal funds rate is effectively zero. So returns on bond investments and CDs these days are very low — unprecedently low.

The interest rates are low because the economy has been weak. During the 1950s and 1960s GDP growth per annum averaged about 5%. During the last twenty years it has averaged about 2%. Trying to stimulate growth, the Federal Reserve has gradually lowered rates. Having reached zero, they can’t lower them any more.

Low rates enable a high level of borrowing. So the economy is riddled with debt (corporate, governmental, household, student). The threat of a debt deflation crisis has motivated the Federal Reserve to buy bonds to support the bond market — in addition to keeping rates low.

The Fed stimulus also supports stock prices. High stock prices mean that dividend yields are low (they’re around 2%) and the prospects for future capital gains are low.

Stock prices don’t figure to go much higher and interest rates can hardly go any lower.

At the end of this particular long-wave cycle, returns on investments are so low as to be problematic. After all, to meet future obligations pension funds rely on decent returns. They depend on portfolio returns of six or seven percent. If the returns are actually only two or three percent for an extended period of time they won’t be able to make the expected payouts.

Also: The Fed is trying to fight deflation, but low returns add to deflationary pressures. To avoid a deflationary spiral they keep “priming the pump.” It drives too-high stock prices even higher and it increases inequality (because the already-wealthy own the lion’s share of equities). But failing to print money, expand credit, and buy bonds could result in bankruptcies, defaults, and a debt-deflation collapse worse than the Great Recession.

Seeing interest rates at zero percent, we know that they’re facing a conundrum. No one knows what the outcome will be.