- Inflation was so bad the government issued bonds denominated in foreign currencies…
- When it comes to interest rates, you need to “get real”…
- Jim Rickards warns about a NEW kind of market crash…
Dear Reader,
Are today’s interest rates actually higher than the early 1980s — when rates went skyshooting?
A lunatic question, you thunder. And one worthy of a bedlamite in an asylum.
Your objection is noted… and entered into the record.
Yet I encourage you to get “real.” Details to follow.
Let us first sit down with the facts.
The year is 1979. And the United States dollar was a sawdust asset.
Inflation ran to a dollar-sawing 13.3%.
The United States government could not attract purchasers of its bonds… even if signed by an angel of God.
Uncle Samuel had been compelled the year prior to issue bonds denominated in Swiss francs and West German marks.
How to Tame an Inflationary Tiger
Also in 1979 new Federal Reserve chairman Paul Volcker came on station.
Mr. Volcker had an inflationary tiger on his hands.
1980 inflation roared at a mighty 13.5%.
Yet he had his whip and chair out… determined to cage the rampaging beast.
The average federal funds rate (the rate the Federal Reserve controls directly) ran to a tiger-taming 13.35% in 1980.
By 1983 Mr. Volcker had inflation substantially caged at a tolerable 3.8%.
Now come home…
The 1980s vs. the 2020s
The United States economy has endured a hagriding inflation in recent years… cresting 9.1% in June 2022.
The latest inflation reading came in at 2.3%.
Thus the recent inflation is as tame as a tabby — against the inflation of the late 1970s and early 1980s, that is.
Yet what of interest rates?
Recall: The average federal funds rate registered 13.35% in 1980.
In recent years Mr. Powell never ran the federal funds rate above 5.33% — even in the teeth of the 2022 rages.
Today the federal funds rate dangles at 4.33%.
Yet could today’s 4.33% rate actually exceed 1980’s average 13.35% rate?
It can — and does — once you “get real.”
The Real Rate
The “real” interest rate is the nominal interest rate minus the inflation rate.
Assume a nominal interest rate of 3% for example. Assume further a 1% inflation rate.
In this instance we find the real rate is 2% (3 – 1 = 2).
Now consider the case before us.
Nominal interest rates averaged 13.35% in 1980.
Meantime, 1980 inflation averaged 13.5%.
Let us then apply our fingers-and-toes mathematics to arrive at the real interest rate in 1980.
We take 1980’s average nominal interest rate (13.35%). We then subtract the inflation rate (13.5%).
We come to the arresting conclusion that 1980’s real interest rate was not 13.5%… but -0.15% (13.35 – 13.5 = -0.15).
Once again:
1980’s average nominal rate was 13.35%.
Yet its average real interest rate was -0.15%.
When 4.33% Is Higher Than 13.35%
Now roll the reel forward to 2025.
Today’s nominal fed funds rate goes at 4.33%.
Meantime, official consumer price inflation runs to 2.3%.
To discover today’s real interest rate, we once again subtract the inflation rate from the nominal rate.
What do we discover?
We discover that today’s real interest rate hovers at 2.03%.
That is, despite today’s vastly lower nominal rate (13.35% versus 4.33%)… today’s real interest rate exceeds 1980’s (2.03% versus -0.15%).
Shocking — but there you are.
“Real Rates Are What Determine Investment Decisions”
We must then conclude that nominal interest rates lack all meaning absent the inflation rate.
That is why it is labeled the real interest rate.
The real rate penetrates numerical mists. It scatters statistical fogs.
It clarifies.
As explains Freedom Financial News contributor Jim Rickards:
“Real rates are what determine investment decisions.”
A 10-year Treasury note yielding 7% might reel you in, for example.
Yet what if inflation averaged 8% over those 10 years?
Inflation would gobble your 7% yield — and a bit more into the bargain.
You would require a 9% yield merely to paddle ahead of inflation.
Meantime, you may balk at a 10-year Treasury bond yielding 3%.
Yet if inflation runs at 2% across those 10 years… your 3% Treasury yields you 1%.
A slender gain, yes. Yet you escape with your skin — and a slight surplus.
What’s the Big Deal?
“So what?,” you say.
“So today’s real rate is higher than 1980s. Sure, it’s interesting. But what does it matter?”
It matters for this reason, argues Phoenix Capital Research:
- Inflation is at [2.3%]… and the Fed has rates at [4.33%] and is still running Quantitative Tightening (QT). This is EXTREMELY tight monetary policy and it’s highly likely something is going to break soon.
- With inflation at 2.3% and rates at 4.33%, this means that real rates, or inflation-adjusted rates are at positive 2%. Historically, over the last 25 years, any time real rates have been this positive, it’s only been a matter of time before something broke in the financial system.
If it is evidence you seek… then it is evidence you shall have:
Sources: Board of Governors of the Federal Reserve System, U.S. Bureau of Labor Statistics, Phoenix Capital Research
Time for the Fed to Get Real
The 25-year record is clear as gin.
Each instance the real interest rate exceeded 2%, it had been a mere matter of time before “something broke in the financial system.”
How much time? The answer of course varies — the financial system does run to tight scheduling.
Something might break in the financial system next month, next year, the next two years.
We must also concede the possibility that nothing within the financial system will break — at least not for years and years.
We can merely glance backwards in search of patterns… and project these patterns forward.
At times they will prove instructive. At other times, they will not.
Yet if Phoenix Capital Research has hooked onto something… Mr. Powell and mates had better get real.
Brian Maher
for Freedom Financial News
