This week at my university the Economics Department Co-hosted an event titled “Interest Rates and Student Loans” with the Office of Financial Aid. I discussed interest rates for a broad audience of young adults. Below is my talk on interest rates.
*None of what I say is financial advice for you.
If you are feeling OK about the world after a nice Labor Day weekend, I can fix that. How about six reasons why global economic growth will slow to a crawl, courtesy of perma-bear Charles Hugh Smith?
Smith is recognized as an earnest, good-willed alternative economic thinker. His OfTwoMinds blog and other publications bring out many valid facts and factors. He has been extrapolating from those factors to global financial collapse for well over fifteen years now, growing out of the imminent peak oil movement of circa 2007 vintage and the scary 2008-2009 financial crisis. Obviously, he has continually underestimated the resilience of the national and global systems, especially the ability of our finance and banking folks at keeping the debt plates spinning, and our ability to harness practical technology (e.g. fracking for oil production). Smith recommends preparing to become more self-reliant: we should learn more practical skills, and prepare to barter with local folks if the money system freezes up.
For now, I will let him speak for himself, and leave it to the readers here to ponder countervailing factors. From August 11, 2024, we have his article titled, These Six Drivers Are Gone, and That’s Why the Global Economy Is Toast:
The six one-offs that drove growth and pulled the global economy out of bubble-bust recessions for the past 30 years have all reversed or dissipated. Absent these one-off drivers, the global economy is stumbling off the cliff into a deep recession without any replacement drivers. Colloquially speaking, the global economy is toast.
Here are the six one-offs that won’t be coming back:
1) China’s industrialization.
2) Growth-positive demographics.
3) Low interest rates.
4) Low debt levels.
5) Low inflation.
6) Tech productivity boom.
( 1 ) Cutting to the chase, China bailed the world out of the last three recessions triggered by credit-asset bubbles popping: the Asian Contagion of 1997-98, the dot-com bubble and pop of 2000-02, and the Global Financial Crisis of 2008-09. In each case, China’s high growth and massive issuance of stimulus and credit (a.k.a. China’s Credit Impulse) acted as catalysts to restart global expansion.
The boost phase of picking low-hanging fruit via rapid industrialization boosting mercantilist exports and building tens of millions of housing units is over. Even in 2000 when I first visited China, there were signs of overproduction / demand saturation: TV production in China in 2000 had overwhelmed global and domestic demand: everyone in China already had a TV, so what to do with the millions of TVs still being churned out?
China’s model of economic development that worked so brilliantly in the boost phase, when all the low-hanging fruit could be so easily picked, no longer works at the top of the S-Curve. Having reached the saturation-decline phase of the S-Curve, these policies have led to an extreme concentration of household wealth in real estate. Those who favored investing in China’s stock market have suffered major losses.
( 2 ) Demographics
Where China’s workforce was growing during the boost phase, now the demographic picture has darkened: China’s workforce is shrinking, the population of elderly retirees is soaring, and so the cost burdens of supporting a burgeoning cohort of retirees will have to be funded by a shrinking workforce who will have less to spend / invest as a result.
This is a global phenomenon, and there are no quick and easy solutions. Skilled labor will become increasingly scarce and able to demand higher wages regardless of any other factors, and that will be a long-term source of inflation. Governments will have to borrow more–and probably raise taxes as well–to fund soaring pension and healthcare costs for retirees. This will bleed off other social spending and investment.
( 3 ) The era of zero-interest rates and unlimited government borrowing has ended. As Japan has shown, even at ludicrously low rates of 1%, interest payments on skyrocketing government debt eventually consume virtually all tax revenues. Higher rates will accelerate this dynamic, pushing government finances to the wall as interest on sovereign debt crowds out all other spending. As taxes rise, households are left with less disposable income to spend on consumption, leading to stagnation.
( 4 ) At the start of the cycle, global debt levels (government and private-sector) were low. Now they are high. The boost phase of debt expansion and debt-funded spending is over, and we’re in the stagnation-decline phase where adding debt generates diminishing returns.
( 5 ) The era of low inflation has also ended for multiple reasons. Exporting nations’ wages have risen sharply, pushing their costs higher, and as noted, skilled labor in developed economies can demand higher wages as this labor cannot be automated or offshored. Offshoring is reversing to onshoring, raising production costs and diverting investment from asset bubbles to the real world.
Higher costs of resource extraction, transport and refining will push inflation higher. So will rampant money-printing to “boost consumption.”
( 6 ) The tech productivity boom was also a one-off. Economists were puzzled in the early 1990s by the stagnation of productivity despite the tremendous investments made in personal and corporate computers, a boom launched in the mid-1980s with Apple’s Macintosh and desktop publishing, and Microsoft’s Mac-clone Windows operating system.
By the mid-1990s, productivity was finally rising and the emergence of the Internet as “the vital 4%” triggered the adoption of the 20% which then led to 80% getting online combined with distributed computing to generate a true revolution in sharing, connectivity and economic potential.
The buzz around AI holds that an equivalent boom is now starting that will generate a glorious “Roaring 20s” of trillions booked in new profits and skyrocketing productivity as white-collar work and jobs are automated into oblivion.
There are two problems with this story:
1) The projections are based more on wishful thinking than real-world dynamics.
2) If the projections come true and tens of millions of white-collar jobs disappear forever, there is no replacement sector to employ the tens of millions of unemployed workers.
In the previous cycles of industrialization and post-industrialization, agricultural workers shifted to factory work, and then factory workers shifted to services and office work. There is no equivalent place to shift tens of millions of unemployed office workers,as AI is a dragon that eats its own tail: AI can perform many programming tasks so it won’t need millions of human coders.
… As for profits, as I explained in There’s Just One Problem: AI Isn’t Intelligent, and That’s a Systemic Risk, everyone will have the same AI tools and so whatever those tools generate will be overproduced and therefore of little value: there is no pricing power when the world is awash in AI-generated content, bots, etc., other than the pricing power offered by monopoly, addiction and fraud–all extreme negatives for humanity and the global economy.
Either way it goes–AI is a money-pit of grandiose expectations that will generate marginal returns, or it wipes out much of the middle class while generating little profit–AI will not be the miraculous source of millions of new high-paying jobs and astounding profits.
(End of Smith excerpt; emphases mainly his)
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Have a nice day…
I’ve written about government spending before. But not all spending is the same. Building a bridge, buying a stapler, and taking from Peter to pay Paul are all different types of spending. I want to illustrate that last category. Anytime that the government gives money to someone without purchasing a good or service or making an interest payment, it’s called a ‘transfer’. People get excited about transfers. Social security is a transfer and so is unemployment insurance benefits. Those nice covid checks? Also transfers.
Here I’ll focus on Federal transfers, though the data on all transfers is very similar if you include states in the analysis. Let’s start with the raw numbers. Below is data on GDP, Federal spending, and federal transfers. Suffice it to say that they are bigger than they used to be. They’ve all been growing geometrically and they all exhibit bumps near recessions.
Continue readingI keep reading and hearing people who are waiting for the shoe to drop on the next recession. They see high interest rates and… well, that’s what they see. Employment is ok and NGDP is chugging along.
One indicator of economic trouble is the delinquency rate on debt. That’s exactly what we would expect if people lose their job or discover that they are financially overextended. They’d fail to meet their debt obligations. But the broad measure of commercial bank loans is quiet. Not only is it quiet, it’s near historic lows in the data at only 1.25% in 2023Q2. Banks can lend with a confidence like never before.
But maybe that overall delinquency rate is obscuring some compositional items. After all, we know that many recessions begin with real-estate slowdowns. Below are the rates for commercial non-farmland loans, farmland loans, and residential mortgages. All are near historical lows, though there are hints that they’re might be on the rise. But one quarter doesn’t a recession make. I won’t show the graph for the sake of space, but all business loan delinquency rates have also been practically flat for the past five years.
Continue readingWhere is that recession that pundits have been predicting for over a year now? The suspense is killing me. Despite savage hikes in interest rates that have led to a collapse in regional banks and in home buying, the economy just keeps chugging along, and inflation continues to run way above the targeted 2% level. What’s going on?
An article I just read on the Seeking Alpha applied finance website points to three interrelated factors. I will cite and credit the author (whose moniker is “Long-Short Manager”; he runs a couple of investment funds) for the content here, while noting that I agree with his points based on other reading. These points all relate to ongoing strong financial position of the (average) American consumer, who mainly drives the spending in our economy.
( 1 ) Reduced Debt Service
The article notes:
The graph above shows household debt payments as a percent of disposable personal income going back to 2000. Since peaking at 13% right before the financial crisis, it steadily improved to 2020, with a subsequent large drop due primarily to lowered mortgage rates (usually the largest debt obligation of a household). It is the lowest it has been this century.
(Although mortgage rates have jumped in the past year, most existing mortgages were taken out pre-2023, when interest rates had been pushed to near zero by the Fed.)
( 2 ) Robust Wage Growth
The next graph from the Atlanta Fed’s wage tracker (note that the methodology used by this tracker is fundamentally different from the Fed’s employment cost index …) shows that job hoppers on average are making about 3% more than core inflation (call that 5%) whereas the average stayer is making a half percent over core inflation. This is allowing people to catch up for the year that they got behind on inflation.
Likewise, the author notes that although job quits have come down in the past year, they remain well above re-COVID levels.
( 3 ) We Are Still Spending Down Gigantic Pandemic Stimulus Windfall
As we have noted earlier, the government/Fed combination dumped some $4 trillion into our collective pockets in 2020-2021. This includes enhanced unemployment benefits as well as direct stimulus payments, at a time when much of our normal spending (e.g., on travel, sports, commuting, etc.) was curtailed. We are still spending down these excess savings at a good clip, which seems to be a fundamental driver of the currently robust economy:
The last figure on the consumer shows how excess savings (defined as the extra savings consumers accumulated during the pandemic due to fiscal transfers and reduced spending due to lockdowns) has evolved – it should now be around 700 billion and ought to be fully depleted by the end of the year – leaving the consumer still with the lowest debt service ratios of the century and wages caught up with inflation. If you are wondering why we haven’t had a recession despite economists saying we will have it within 6 months for about 12 months now, these charts should tell you why. The tailwind from consumers has exceeded any headwinds from reduced investment due to higher rates.
And there you have it.
I have a list of economics topics that I like to teach about because they conflict with the biases of my average student. The list includes fiat currency, inflation, deficits, net exports, and immigration. The list also includes the importance – or lack thereof – of the federal government’s debt. This post walks through a few graphs to do a gut-check of what we think is true and how it compares to reality. For example, do you have a sense of when the debt grew historically and when it was constant? Do you have a sense for when it shrank?
Continue readingLast week President Biden released his Fiscal Year 2023 budget proposal. The annual release of the budget proposal is always exciting for economists that study public finance. The president’s proposal is the first step in the federal budgeting process, which in some cases leads to the full passage of a federal budget by the start of the fiscal year in October (though perhaps surprisingly, the process rarely works as intended).
This year’s budget is especially interesting to look at because it gives us our first look at what post-pandemic federal budgeting might look like. And while the budget has a lot of detail on the administration’s priorities, I like to go right to the bottom line: does the budget balance? What are total spending and revenue levels?
The bottom line in the Biden budget this year is that permanently large deficits are here to stay. Keep in mind that a budget proposal is just a proposal, but it’s reasonable to interpret it as what the president wants to see happen with the budget over the next 10 years (even if Congress might want something different). Over the next 10 years, Biden has proposed that budget deficits remain consistently right around 4.5% of GDP, with no plan to balance the budget in the near future.
How does this compare to past budget proposals? For comparison, I looked at the final budget proposals of Biden plus his two predecessors. I start Obama’s in 2021 to match Trump’s first year, and all three overlap for 2023-2026. I put these as a percent of GDP so we don’t have to worry about inflation adjustments (though we might worry about optimistic GDP forecasts, see below).
I’m not an economist who studies education or bankruptcy, and I’m not 100% confident I spelled dischargeable correctly. I am, however, above average at highlighting the difficulty of a question when dissuading a grad student from attempting an impossible thesis question, so let’s dig into this one, which sounds pretty hard to me.
First of all, it is very difficult to discharge student debt during Chapter 7 or 13 bankruptcy, but I think you still can do it if you convince a judge that continued attempts at repayment would create undue hardship i.e. put you in a state of poverty in the wake of previous good faith efforts.
That said, maybe you shouldn’t have to face literal starvation to discharge student loans. That’s a reasonable idea, but what would the broader consequences be? This is tricky question to untangle because there are both welfare consequences and knock-on effects where we are put down different forking paths of politics and policy.
If debt is dischargable, then lenders will expect lower rates of repayment. This increase in lender risk and decrease in return on capital would likely have immediate consequences in the form of:
Before we tackle those, we also have to consider the different policy environment paths lenders may have to anticipate:
But where this really leaves us is with a billion dollar question: will dischargeable students loans lead to lower costs of higher education? I am confident that the answer is a definitive, unassailable maybe.
Higher interest rates is a pretty straightforward prediction, but the consequences are less clear. Higher interest rates could lead to less college matriculation, greater barriers for lower income individuals, and higher expected rates of bankruptcy, in part because decisions are being made by young people who don’t know the future, their future, or, really, anything. Related to this, lenders will become more discerning regarding who they lend to, giving more money on more favorable terms to matriculants from wealthier backgrounds, in no small part because wealthy parents are filled to the brim with collateral, making for excellent co-signers and providers of high school graduation gifts nicer than any car I ever hope to drive.
That is all boring and moderately obvious. It’s 4) that I’m most curious about. If you get into medical school, there is no shortage of institutions eager to dump several hundred thousand dollars in the foyer of your home. Part of the reason for this is the expected future income of physicians and their high graduation rates from medical school thanks to rigorous admission screening. But what is underappreciated is the 100% rate at which medical school students study medicine.
Not so with undergraduate education. You might study electrical engineering with a minor in computer science. You also might study something a senior tells you is the easiest major at your school. You might major in something that sounds fun or interesting. You might study Miscelleneous Studies, where Miscelleneous is a subject that is likely interesting and possibly extremely important, but within which you can choose classes that facilitate your avoiding learning anything useful or applicable in the labor market.
Herein lies the problem. Lenders treat loans for consumption very differently than loans for investment. Nursing and statistics degrees are investments. Art History classes (for most people) are consumption. What’s going to happen to higher education when the lender tells you you can have $200K at 3% to study any STEM field or $75K at 6% to study anything in the humanities? Will the demand for humanities degrees drop? Will the supply of humanities education recede? Are humanities and STEM education complements or substitutes?1
Let me phrase it a different way? Are wealthy fine arts majors cross-subsidizing STEM majors pursuing the first college degrees in their family? Or are they driving up the price of tuition because heavily subsidized credit is facilitating pre-career retirement lifestyles for 4 years?
All of this leaves me with the suspicion that dischargeable student loans will lower tuition for some while raising it for others. This heterogeneity would likely shift the electoral popularity of free tuition programs while also shifting the nature of those program. Maybe “free college” turns into a means-tested program. Maybe “free college” becomes “free STEM college”. Maybe both.
We could speculate what this means for loan forgiveness or subsidies, but this post is too long already and, as should be already clear, we’re not going to solve anything today. My elegant and succinct point is this:
When you massively subsidize a [knowledge, signal] bundled good for so long that it transforms into a [knowledge, signal, 4-year luxury cruise with your peers] bundle, and to accommodate that subsidy you protect your poorly constructed macro-investment in human capital by exempting it from bankruptcy proceedings, and as a result of this weird landscape a bizarre higher education industry emerges that is both one of the greatest achievements in US history but also a trap that 19-year-olds fall into because, really, is there any trap we don’t fall into when we’re 19, and from which thousands of people never financially recover, but if you just fix one part of it no one knows what will happen, and if you try to fix all of it at once in the back of your mind you’re afraid it could turn into the US healthcare industry part deux, well then what you have is a real and important problem that I don’t know how we will solve but I remain confident that other people will be very confident that they know how to solve it and they will get extremely cross with me for not sharing their confidence.2
So maybe don’t try to solve that in your dissertation.3 Might be safer to just definitively estimate the natural rate of interest that underlines all monetary transactions. That’ll be easier.
1The answer is “Yes”.
2 This is, to be extremely clear, not me picking on Ms. Reisenwitz’s tweet which was good and interesting and left me thinking about student loans for two days when I should have been working on the research topics I have actual expertise in.
3 Of course, if you do find a natural experiment where huge chunks of student debt were accidentally made dischargeable in a state for 2 years because of a legislative SNAFU, you should write that dissertation and put me in the acknowledgements.
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