SIMON BROWN: I’m chatting now with Adrian Saville [investment specialist] at Genera Capital and, of course, Gibs Business School. Adrian, I appreciate the early morning. There’s something that I’ve been pondering, so I thought I’d get the expert on [it] to help me understand. Interest rates: I’m looking at the US 10-year [bond], … the UK 30-year and the like. After a decade or two or – in the case of the US, four decades of trending lower – suddenly we are sitting at higher rates. The 10-year in the US is above 4%. And, my sense is that probably over the decade going forward rates [will be] higher than the previous decade. This must be worrying governments the world over because, simply, interest builds.
ADRIAN SAVILLE: Good morning, Simon. I think this is a critical question at this juncture in economics and in investing, and in politics, because the multi-trillion dollar question is where do interest rates go, guided I think for the very near future by inflation rather than by social imperatives. Because, through the course of Covid in particular, social imperatives got hold of the wheel and it became a case of ‘we have to spend’ – almost regardless – to get to the other side of the pandemic.
Now that we are on – let me touch wood – the other side of the pandemic, it’s evident that a lot of the policy actions of the last decade or even more have translated into a long-time threat, which is the threat of inflation. And as much as the pandemic can hammer a society very, very hard in a short time, inflation can be a slow-grinding burn, which steadily confiscates the prosperity and the wellbeing of a society. That’s the enemy or the evil that has come to the fore, and we’re now looking at fairly persistent high single digits or, in some cases, double-digit inflation in the advanced economies, and the policy instrument to address that is interest rates. To put it simply, and I guess answer your question very directly, 4% interest rates don’t solve 7% inflation.
SIMON BROWN: Well, absolutely. You’ve made that statement before. We need much higher interest rates, which means if we don’t get the higher rates – and the Federal Reserve, to the question of are they behind the curve, [the answer is yes] – the debate is how far?
ADRIAN SAVILLE: Yes.
SIMON BROWN: That means they might not go high enough, which means inflation doesn’t come down fast enough, as I would read it. Therefore these higher rates stay. I’ve just Googled it and I don’t know if the number’s correct, but it’s in the ballpark – US debt to GDP is around 120%.
ADRIAN SAVILLE: And if you take that 120% and then multiply it by a long-term cost of funding of 5%, for the sake of a round number, that’s what the US would need to fund each year.
Now, the US is a bit of a curious animal, because all of their debt is issued in dollars, which means they can essentially print all of their debt and, as long as they do it at a reasonably sane rate, they’ll get inflation that will be elevated but not pernicious and destroy society.
When you get countries that have debt that they can’t fund away, and they rather elect to print away in their own currency, you can get into galloping inflation, and in the worse case hyperinflation. We’ve got the examples of Zimbabwe, Venezuela, Argentina constantly wrestling with 50% inflation, Turkey with 70/80% inflation.
If you think of what an 80% cost of living would do to your ability to look after your family, that gives you a sense of just how damaging inflation is.
What we also need to be mindful of is that the economic response to rising interest rates is very inexact and it’s delayed, which means as much as I’m saying 4% interest rates might not be enough to kill 7%, 8%, 10% inflation, as an economic policy position we won’t know that until we get there because it may well be the case that people’s debt burdens – their interest-rate expenses – actually curtail spending in all other types of places and you get demand sitting down, and then inflation falls away.
This is a very, very inexact science and, given the amount of money that has been printed, and for how long we’ve been at zero interest rates, and then the level of debt, we’re in unmapped territory.
SIMON BROWN: Yes, we are in unmapped territory. I hadn’t actually thought of that. It ripples through and I’m think it’s the same for corporates because, of course, everyone’s got debt. The cost goes up. Maybe it does kind of solve its own solution.
But I think the key point is it’s kind of a slow-motion event playing out, and we’ll see how it goes.
Adrian Saville of General Capital, I always appreciate the early morning insight.
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