In May 2014 many of us were shocked by a report that Ben Bernanke, who had recently departed the Fed, told a group of wealthy investors that he did “not expect the federal funds rate…to rise back to its long-term average of around 4%” in his lifetime.
I remember feeling Bernanke’s statement represented both extraordinary hubris and wishful thinking. Surely, the trillions being pumped into the financial system would drive inflation to levels that would produce higher rates. After all, I reasoned, the bond market isn’t as easily manipulated as is the stock market.
Last year, I called attention to the fact that the cost of servicing the US debt had broken out to new highs [see: Why Rising Rates are a Problem This Time.] Even though interest rates had fallen dramatically, the spiraling debt had send annual interest expense on that debt to roughly $450 billion in FY 2017.
Clearly, if rates were to normalize the interest expense would be unmanageable… Between 2000 and 2007, the average interest rate was 4.84%. On the current $20.6 trillion balance, that would mean an annual interest expense of roughly $1 trillion.
Of course he was confident in his prediction! He understood that rates could never be allowed to rise. A return to normalcy — and, I don’t believe this to be an exaggeration — would absolutely destroy the economy.
I had always found the Treasury’s increasing dependence on short-term, floating rate and inflation-indexed borrowings a bit unsettling. Why not lock in a boatload of 30-yr bonds at 2.1%? Now we know.
In their wisdom (or desperation…time will tell) the central bankers and those maxing out America’s Gold Card have bet our very futures that Bernanke was right — that everything will be okay in the end…as long as the end never gets here.
By the way, here’s an update of the above chart…which has been appropriately renamed.