Wall Street is always quick with colorful disaster metaphors, and the latest market convulsion has already been dubbed the “bondcano.” But a little lava spillage can be a hopeful sign. For the first time since the financial crisis of 2008, a strange cloud that has hung over the economy may finally be lifting.
By most measures, the economy has performed well since 2008. The recovery has lasted for 103 months and will soon rank as the second-longest post-war expansion. Gross Domestic Product is up by 2.5 percent over the past year, not bad for a graying society; unemployment is at a rock-bottom 4.1 percent. But an uneasy feeling has haunted the celebration. No matter how many jobs the economy created, many feared it would never return to the pre-crisis condition in which buoyant hiring could coexist with decent returns for savers.
This pessimism has been most evident among Federal Reserve leaders. Members of the Fed’s monetary committee regularly publish their views of the appropriate long-run interest rate, known as “R*” in the jargon. This is the interest rate that the economy needs to achieve stable inflation and maximum employment. A high R* is generally good news: It means that businesses want to borrow and expand aggressively, so you can get to full employment even when interest rates are relatively high. Workers can do well even as savers do well. Think back two decades, when unemployment was low, wages were rising and savers enjoyed a risk-free 5.5 percent return on their money.
The bad news is that, in the judgment of Fed leaders, R* has come down sharply. Since 2012, the median estimate of the long-run interest rate published by monetary committee members has fallen from a bit over 4 percent to under 3 percent. This means that, stripping out inflation, the estimate for the real interest rate has collapsed by about two-thirds. Businesses seem unexcited about borrowing and investing, the Fed chiefs are saying. Interest rates will have to stay low to generate full employment.
For anyone with a retirement fund, this is a grim prospect. The lower the return on savings, the more you have to set aside to afford retirement. For the past several years, admittedly, this truth has been obscured: Stocks have had a glorious run as low interest rates have chased savings into the markets. But that portfolio shift is probably over, and may well have overshot. From here on out, workers seeking to build up their retirement funds may have to save more and work longer.
How did the economy get stuck in this rut? The gloomy estimates of R* reflect a conviction that, even before the 2008 shock, powerful forces were pushing down on interest rates. The aging of the baby boomers boosted the saving rate. So did the rise in inequality—more of the national income was flowing to people who could afford to save it. The growing supply of capital was met with falling demand for capital, pushing down the natural interest rate further. Slowing productivity gains suggested that there were not that many great machines that businesses wanted to buy — hence sluggish business investment. Even the exciting breakthroughs in Silicon Valley were not capital-hungry. You can launch a ride-sharing company or a digital coin without buying much machinery.
So far, so pessimistic. But the United States has a history of defying gloomy predictions. Economists predicted “secular stagnation” in the 1940s, right before the 1950s boom, and today there are signs that Fed estimates of R* are too cautious.
Jason Cummins, the research chief at a major hedge fund and a candidate to lead the New York Fed, points out that capital expenditure is recovering; expectations of capital expenditure are soaring; and the personal saving rate has fallen back to its pre-crisis low. In Washington, the Trump tax cut means that the government saving rate is falling dramatically as well. We are back on the path to a trillion-dollar deficit.
Meanwhile in Silicon Valley, some venture capitalists are shifting to capital-hungry projects—medical robotics, next-gen nuclear fusion, satellites and so on. Globally, healthy economies have dulled investors’ urge to park money in the United States because of its safe-haven status.
All of which suggests that savings in the United States will be less abundant, demand for them will be more abundant, and the natural interest rate will move higher. Unless markets suddenly reverse themselves, the recent ‘bondcano’ probably reflects an awakening: When investors revise up their view of interest rates, bond prices tumble. For many professional money managers, these may well be scalding times.
But for the economy as a whole, a higher R* would be a sign that the post-2008 malaise is finally healing.