What Interest Rate Triggers The Next Crisis?
- The Ten-year U.S. Treasury note yields 1.61%.
- 10-year high-quality corporate bonds yield 2.09%.
- The rate on a 30-year mortgage is 3.05%.
Despite recent increases, interest rates are hovering near historic lows. We do not use the word “historic” lightly. By “historic,” we refer to the lowest levels since the nation’s birth in 1776.
The graph below, courtesy of the Visual Capitalist, highlights our point.
Despite 300-year lows in interest rates, investors are becoming anxious because they are rising. Recent history shows they should worry. A review of the past 40 years reveals sudden spikes in interest rates and financial problems go hand in hand.
The question for all investors is how big a spike before the proverbial hits the fan again?
Debt-Driven Economy
Over the past 40 years, debt has increasingly driven economic growth.
That statement on its own tells us nothing about the health of the economy. To better quantify the benefits or consequences of debt, we need to understand how it was used.
When debt is used productively, the interest and principal are covered with higher profits and sustained economic activity. Even better, income beyond the cost of the debt makes the nation more prosperous.
Conversely, unproductive debt may provide a one-time spark of economic activity, but it yields little to no residual income to service it going forward. Ultimately it creates an economic headwind as servicing the debt in the future replaces productive investment and or consumption.
The graph below shows the steadily rising ratio of total outstanding debt to GDP. If debt, in aggregate, were productive, the ratio would be declining regardless of the amount of debt.
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