There has been much discussion as of late about the end of the current quantitative easing program and the beginning of the Federal Reserve “normalizing” interest rates. The primary assumption is that as interest rates normalize, the financial markets will continue to rise as economic growth strengthens. While this certainly seems like a logical assumption, is it really the case?
As I discussed in “The Great American Economic Growth Myth:”
“From 1950-1980 nominal GDP grew at an annualized rate of 7.55%. This was accomplished with a total credit market debt to GDP ratio of less 150%. The CRITICAL factor to note is that economic growth was trending higher during this span going from roughly 5% to a peak of nearly 15%. There was a couple of reasons for this. First, lower levels of debt allowed for personal savings to remain robust which fueled productive investment in the economy. Secondly, the economy was focused primarily in production and manufacturing which has a high multiplier effect on the economy. This feat of growth also occurred in the face of steadily rising interest rates which peaked with economic expansion in 1980.”
This is clearly shown to be the case in the chart below.
It is important to note in the chart above that each time the business/economic cycle slowed, interest rates never fell to a level lower than they were previously. As economic growth, while bumpy, trended higher over time; so did interest rates.
As I wrote previously, that all changed.
“However, beginning in 1980 the shift of the economic makeup from a manufacturing and production based economy to a service and finance economy, where there is a low economic multiplier, is partially responsible for this transformation. The decline in economic output was further exacerbated by increased productivity through technological advances and outsourcing of manufacturing which plagued the economy with steadily decreasing wages. Unlike the steadily growing economic environment prior to 1980; the post-1980 economy has experienced by a steady decline. Therefore, a statement that the economy has had an average growth of X% since 1980 is grossly misleading. The trend of the growth is far more important, and telling, than the average growth rate over time.”
