Although the president Donald Trump wishes lower interest rates, in order to achieve this goal, more obstacles should be overcome by its president FedJerom Powell.
According to Bloomberg report, there are structural forces that affect the costs of borrowing and, at the moment, show an upward trend. Governments and businesses accumulate debt to pay tax cuts, military spending and investment in artificial intelligence, which means greater demand for credits. As baby boomers retire and China is disconnected from the US, the savings stock to finance these loans is exhausted. Donald Trump’s attacks on Fed’s independence. Particularly on the issue of interest rates, they are in danger of further shrinking the stock. Investors do not want to see the value of the efforts of their earnings to swell from a central bank under political control.
Combining all of this, we end up in a world where 4.5% can be the new normal for ten years of US government bonds – the crucial interest rate on mortgages and corporate bonds, and what Trump’s team says it wants to reduce. In fact, Bloomberg Economics analysis shows that it is more likely to move above this percentage than below. For the world’s largest economy, this means a painful transition.
For more than three decades, the decline in borrowing costs changed the whole landscape. Washington could accumulate more and more debt without breaking the books. Cheap funds fueled US real estate and shares. All of this has now been reversed, as the US is facing a future where interest payments cost more than defensive costs and 7% mortgage interest rates affect housing prices.
All of this corrects Trump’s claim that a new Fed leader can “make” everything. It is true that Powell controls the cost of short -term loans and is likely to reduce it in the coming months. The signs of labor market weakness and the early departure of Fed Adriana Kougler – which means an opportunity for Trump to appoint a supporter of low interest rates to replace it – increase the chances of paying interest rates in September.
However, if we look at the fluctuations in the cycle, we find that there is a deeper logic. The price of money – like any other price – is determined by the balance between supply and demand. Increasing savings supply means falling interest rates. Increasing investment demand means rising.
In finance manuals, the price of money that balances savings and investment demand while maintaining high employment and low inflation has a name: the natural interest rate. For more than three decades, from the early 1980s to the mid -2010s, this interest rate was reduced. Now, it is growing.
What led to a reduction? A lot of things. On the part of the savings, the Baby Boom generation – born in the shorten after World War II – worked hard and saving money for retirement. China had a huge trade surplus and to prevent the appreciation of its currency recycled revenue from exports to public bonds. Saudi Arabia and other oil -producing countries were in a similar position with revenue from oil exports invested in US government bonds
Fed’s independence, with presidents from Ronald Reagan to Barack Obama not involved in interest rates, provided the assurance that the value of savings would not be underestimated, enhancing the attractiveness of public bonds as a safe shelter.
In terms of investment, the golden years of the rapid increase in productivity that followed World War II began to fade into memory. As US growth was reduced by an average of more than 4% in the 1960s to less than 2% in the 2000s, profitable investment opportunities declined respectively. The end of the Cold War meant a dividend of peace, with the reduction of defense spending contributing to controlling public debt. In 2001, US debt was just over 30% of GDP and the state budget was surplus.
The decline in the price of information technology has contributed to it. Moore’s law – according to which the number of transistors in a microchip is doubled every two years – was precisely in force. Businesses could gain more and more computational power with less and less investment funds.
By combining all these elements, the abundant savings offer and the limited demand for investment have led to a fall in the natural interest rate of long -term loans. Bloomberg Economics calculations show a fall from a high level of about 5%, adapted to inflation in the early 1980s, to a low level of about 1.7% in 2012.
Now, these trends are reversed. The Baby Boom generation retires by spending its pensions instead of adding savings to the fund. China let its currency ranges, which means that it no longer needs to buy dollars to prevent it. From the early 1990s to 2014, China’s foreign exchange reserves increased from almost zero to almost $ 4 trillion. Since then, they have been reduced to $ 3.3 trillion.
Saudi Arabia and other oil -producing countries followed a similar course by shifting their attention from public bond markets to higher costs for projects closer to their home country and investing in businesses in the future. Investments in Neom, the futuristic city of Prince Mohammed bin Salman in the desert may reach the trillions of dollars.
Geopolitics also plays a role. In 2022, after Russia’s invasion of Ukraine, the US and their allies froze about $ 300 billion in Kremlin assets. The goal is to stop the funding of Putin’s war machine. The side loss, the conversion of the Treasury’s debt to an economic policy tool, thereby reducing its value as a reserve asset. Other countries do not want to place their savings in the US if the US can confiscate them.
A more dangerous world has put an end to the benefits of peace, forcing governments to increase defense spending. NATO European members agreed to increase their military budgets to 3.5% of GDP from the previous 2% target. Bloomberg Economics estimates that lending to cover this increase will add about 2.3 trillion. dollars in Europe’s debt over the next decade.
With investors facing German and French debt as narrow substitutes of the American, borrowing in Berlin and Paris means higher interest rates for Washington. US debt approaching 100% of GDP increases pressure.
The retirement of Baby Boomers, the end of the excessive savings from China and the oil -producing countries, as well as the increase in borrowing from governments have changed the direction of the natural interest rate from downward to upward. Bloomberg Economics calculations suggest that it has already risen from 1.7% in 2012 to about 2.5% in 2024. Based on possible developments in demographics, debt and other factors, it will reach 2.8% by 2030 – maintaining the interest rate of ten -year bonds between 4,5% and 5%.
This may seem as a slight increase. For a change in the basic interest rate that determines the price of money throughout the global financial system, it is enormous. And the risks tend upwards, not down.
Climate change always seems to be the challenge of tomorrow, never today. If the US decides to deal with the issue of decline seriously, Bloomberg estimates the cost of moving to net energy to $ 10 trillion. Artificial intelligence promises a radical change in growth, to achieve this will require huge investment in data centers, the electricity grid and the restructuring of the operating factories and offices. Higher military spending will make it difficult for governments to put in order to put into their budget.
Trump’s attacks on Central Bank’s independence also have their price. The 47th president has openly expressed his demand for lower interest rates and his threats to dismiss Powell. Last week, he described him as “very angry, very stupid and very political”.
If Trump appoints a supporter of low interest rates as the next Fed president, he will achieve lower short -term interest rates. However, undermining the credibility of the Fed as an inflation fighting body, it will risk increasing the long -term borrowing costs, as global savings will be removed from US markets.