No Inflation No Problem

Pascal Bedard
Feb 10, 2019 · 4 min read

When you read market commentators and “analysts”, they keep talking about “the debt” and “credit”: government debt, corporate debt, household debt, etc. They then say that “if interest rates increase, it will trigger defaults and rollover problems and more fiscal pressure”… and that would be the “Crisis of All Crises”… and they’re right. Except that in their logic, they have an important hypothesis: that interest rates will indeed increase! It’s not that simple!

The issue is that their fears of rising interest rates rest on the cause of rising interest rates, which is rising inflation… yet, here is the catch: there is NO inflation!

Here is the inflation rate for the USA, the Eurozone, and Canada, 2000–2019… and this is total inflation, which is higher than “core inflation” typically used as an operational guide for central bank policy:

There is NO inflation!

Since the main driver of interest rates is inflation and expected inflation, and since inflation AND expected inflation are low and not menacing at all, there is simply NO risk of rising interest rates.

I know what you are thinking: “yeah but when interest rates DO increase significantly, THEN we will have the mother of all crashes.”

First, I agree that IF inflation rises truly significantly and seems to hold at high levels, we would have quite a few problems, because we do have an explosive mix:

  1. The US corporate debt and federal debt levels are very high relative to income or relative to any other measure.
  2. US taxes could potentially increase (since they are low), but that would cause a slowdown AND maybe a lot of political and social tension. Same for cutting government programs, which are already slim relative to other countries.
  3. Japan simply can’t allow interest rates to rise due to their debt-to-GDP debt load (which is high EVEN when you remove bonds held by the central bank), so they would have to support bond prices by massive purchases, which would be more inflationary still.
  4. The Euro Area is barely holding together with zero interest rates and many countries would have a lot of strain if rates rose convincingly, which could bring us to the mother of all crises: Italexit or other Euro-trigger causing global panic.
  5. Canada’s housing market has balooned to incredible levels and Canadian households are very much in debt, so significantly higher interest rates would trigger the domino effects that could get quite ugly for Canada.

There’s more. So, yes, “if interest rates rise significantly, we are doomed.” But they will not!

Why will interest rates not rise?

  1. Inflation is nowhere to be found and globalization, demographics, and already-high debt loads are the opposite of the mix required for inflation (more on this later — keep reading).
  2. Central bank people know this! They don’t need to read my blog posts to know that they can’t just crank up interest rates without restraint!

As I wrote on many occasions in past posts, the “global monetary tightening” will be short lived, and, in fact, is probably over as of Feb 2019! Why? No inflation and the need for monetary support! Don’t expect this context to change, because it’s going to be more of the same for the next decade.

Inflation ultimately comes from money creation, and money creation comes from DEBT… and debt accumulation comes from households or governments or corporations! In most countries today, debt loads are high and/or people, corporations and governments don’t want to ADD more on top of their big pile or existing debt! Since there will be timid extra debt accumulation (in % of GDP), there will also be timid inflation and interest rate pressure…

As long as inflation stays in check (say it hovers between 1% and 3% everywhere), don’t expect anything special to happen!

Of course, we could have shocks unrelated to interest rates, like wars and political or geopolitical tensions, and so on, but these will not burst bond or housing “bubbles” (whatever that means) as long as central banks can buy assets galore by money creation, which will remain possible as long as there is no inflation. No inflation = no problem.

Pascal Bedard

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