Over the last year, the world's major central banks have tightened their policies more rapidly than has been seen in decades, ending an era of ultra-low interest rates that had become a basic assumption across global commerce and finance.
- We are now in the early stages of a slow-moving process of markets, companies and governments adapting and readjusting to that reality.
Why it matters: Events like the failure of Silicon Valley Bank in March and the debt and currency market freakout over a British fiscal plan last fall are not so much isolated blowups, but early examples of what could be a rolling series of mini-crises in the coming months and years.
- So far, those mini-crises have been well-contained. Last fall, the British government reversed course and the Bank of England intervened to prevent a collapse of pension funds. The American authorities last month protected depositors in SVB and Signature Bank, quelling the storm.
- But as the world adjusts to an era in which money isn't free anymore, it's hard to imagine there will not be bumps along the way, though even well-informed policymakers are modest about their ability to predict where and when they will occur.
State of play: For the 2010s, there were powerful forces keeping interest rates and inflation low, including an abundance of labor, globalization, and inadequate public and private investment. Now that is all flipped on its head.
- The Baby Boom generation is retiring, with smaller generations filling in behind them, making labor more scarce and generating persistent upward pressure on wages.
- A process of deglobalization may be underway, as companies try to add greater resilience to their supply chains and the relationship between the world's two largest economies, the U.S. and China, sours.
- Large-scale investment is underway, including in semiconductors, battery manufacturing and solar cells. Morgan Stanley analysts have called it the "mother of all capex cycles."
Many leading policymakers now believe that these are long-lasting forces, not likely to dissipate any time soon.
- Federal Reserve chair Jerome Powell said in December that "it feels like we have a structural labor shortage out there."
- European Central Bank president Christine Lagarde this week argued that in the new environment, global supply will be less elastic — meaning routine disruptions to activity would cause bigger price spikes than in the past.
- If these views are correct, it implies that the era of near-zero interest rates is over for the foreseeable future and that something resembling today's rates around 5% will be persistent — and there is risk of going higher still.
The problem is that all sorts of institutions have built their business models around a different sort of landscape, including banks, governments and various types of investment funds.
Both the SVB and U.K. tumult reflected the bill coming due for assumptions that the 2010s playbook was still valid — that rates would remain low forever, bankers could take that for granted and policymakers could enjoy a free lunch rather than make tradeoffs.
- The question now is what other pockets of the global financial system will experience a similar readjustment as the impact of high rates ripples through the economy.
It's easier to identify systemic vulnerability than it is to identify exactly where problems will arise. But there are some obvious candidates.
- Banks may soon face big losses on commercial real estate loans as low-rate debt matures and must be rolled over into higher-rate debt — alongside a loss in rent revenue in office buildings due to the work-from-home shift.
- The U.S. government is now forecast to run budget deficits of about 6% of GDP over the next decade, a level that historically only occurred in wars or recessions.
- Higher rates and/or a debt ceiling blowup could create urgency around deficit reduction. The latter could cause a crisis in the Treasury bond market.
Flashback: The 2008 global financial crisis is remembered for the dramatic events of the fall of 2008, after the collapse of Lehman Brothers. But really, the crisis — properly understood, at least — had been underway for more than a year when Lehman fell.
- There had been a series of failures and mini-crises before that, successfully contained by policymakers and doing only modest damage to the real economy. They made headlines at the time, but mostly on the business pages, not the front page.
- The list includes New Century; American Home Mortgage; BNP Paribas hedge funds; Northern Rock; structured investment vehicles; Bear Stearns; and Fannie Mae and Freddie Mac.
The bottom line: There is plenty of reason to think that ripples from higher rates will not cause the kinds of financial catastrophe seen in 2008; the damage could and should be much more contained. The U.S. economy may well escape a recession entirely.
- At the same time, it is hard to imagine that we've seen the end of the disruption caused by such a massive shift in the cost of money.
