Moneybeat: Interest rates and schools of economic thought

MARY REICHARD, HOST: Next up on The World and Everything in It: the Monday Moneybeat.

NICK EICHER, HOST: Time now for our weekly conversation on business, markets, and the economy with financial analyst and adviser David Bahnsen.

He’s head of the wealth management firm The Bahnsen Group and he’s here now.

David, good morning!

DAVID BAHNSEN, GUEST: Well, good morning, Nick. Good to be with you.

EICHER: Short week with the holidays, David, but I see a busy week ahead with the Federal Reserve meeting this week to set the policy target for interest rates, so let’s touch on that before we get to listener questions.

BAHNSEN: Yeah, last week, in the shortened week, you had quite a nice move up in the stock market again. And I think the market expectation continues to be a repricing of expectations for the Fed, meaning that people believe the Fed is going to start slowing down, they're tightening. And if they're slowing down, they're tightening, that means they're getting closer to the point of stopping the tightening, the FOMC will announce, and by the way, the FOMC is the Federal Open Market Committee. And that's the specific group of voting governors in the Federal Reserve Board of Governors who actually get to set interest rate policy. And so the FOMC is sort of an elevated subset of the Federal Reserve. And on Wednesday, they'll announce that they are raising rates half of a percentage point. They have raised rates three quarters of a percentage point the last three meetings. So markets are expecting them to slow down the rate hikes starting this week.

EICHER: Okay, so I think that gives us a good segue into our first listener question this week, David. Here’s listener Sam Burnett.

BURNETT: Good morning, Nick and David. As interest rates rise, could you explain how the rise in interest rates affects the national debt? And is there an interest rate above which the federal government defaults on its loans? Thank you.

BAHNSEN: Well, that's a great question. And obviously, from a mathematical standpoint, the bulk of the United States treasuries debt is in shorter term debt instruments, they have debt that is maturing in 30 years and 20 years. And they have plenty of debt that's maturing in between five and 15 years from now debt that was taken at different points. And it's up to the Treasury to manage what we call the term structure, the different maturity points at which monies are to be paid back. But the bulk of the debt is and always has been very short term. And so it's really enabled a lot of extra borrowing and indebtedness, that the interest rates have been very near 0% for so long.

And now for the first time, you're going to actually see the debt service cost really increase because of higher interest rates. Now, some will say, Won't this be a terrible thing, then I can barely afford it. I would take the opposite approach to say, this is the reason why it won't happen. That In other words, the incentives for the central bank to enable the affordability of government borrowing are so high, that while they have been able to use the interest rate in this period for an extended period of time, they simply can't afford it and therefore won't allow it.

Now, of course, there's always been talk of this thing called ‘bond market vigilantes,' that the bond market will rebel and just simply demand a higher rate of interest to facilitate what they worry about being default borrowing, meaning borrowing that will not end up being able to be paid back. But of course, the problem with that is people thought it was the case when we had a trillion dollars of national debt. And we now have 31 trillion. And so I think those trying to prognosticate what the point of no return is for government indebtedness have lacked the creativity and imagination for excessive spending that the government has not lacked. And I would not dare set a time limit on how far the government is capable of kicking this can.

EICHER: You know, David, we receive lots of questions about interest rates, and I thought this listener’s question was pretty representative of so many, so I’ll use it as a follow-on to this discussion on interest rates. She asks: “You say that interest rates, like all prices, are meant to be discovered. Approximately what do you think the interest rates would be, currently, if that were allowed to happen, and is there any way that can be calculated?” What do you say to that?

BAHNSEN: Well, the irony, of course, in the question is that my position is not merely that 12 PhDs should not be imposing an interest rate, but also that David Bahnsen should not be imposing it. And so to be consistent as an advocate of market setting prices, and not prices being imposed, is that it therefore means I don't believe I could do it either. But I think the question is more predictive, like what would the rate be? And this is one thing that's really bothered a lot of my hard money and sound money friends over the years, is I've never actually thought the cost of borrowing would be significantly higher if the Fed got out of the way of hyper interventionism. The fact of the matter is that demand for US dollars and expectations for future growth - demand for dollars being so high, expectations for future growth being so low - that I don't think the interest rate would have been much higher than it has been. Now one of the ways we know this, Nick is the Fed messes and controls and manipulates the short term rate, the overnight borrowing rate for banks to lend money to banks. They do not have direct market control, they can manipulate it, but not direct control on the ten- year. As a matter of fact, the Fed hasn't bought any 10- year bonds in six months - from the end of 2014 until 2020, they didn't buy any 10-year bonds, and the interest rate stayed around 2%. So this is a negative thing I'm saying: you want the 10-year borrowing costs to be equal to the short term borrowing plus your expectation of growth, the premium you're giving up to lend your money out. So, the cost of time. And when the market is pricing that at two to 3%, they're putting a very low expectation on future growth. So if the question is for me to guess what the short term borrowing rate would be, right now, if the Fed was not involved, and banks were only lending to banks, and yet there was liquidity, you didn't need a lender of last resort, there was functioning financial markets, I think it would be well above zero and well below four - where it is now. So I would guess somewhere closer to three than four, four and a half or five. So this is the first time in least 15 years that I think the Fed is setting the rate above the natural rate. But that of course, is something we're not going to know because this is non-falsifiable. I can't be proven wrong because the market forces will not be setting rates anytime soon.

EICHER: We do have time for one more. David, this is Paul Gebel of Edmond, Oklahoma.

GEBEL: I'm asking this question in honor of my high-school economics teacher, Mr. Paulus. Fifty-two years ago, he made the subject come alive for me, and you're carrying on in that same tradition. So here's my question. Why are there so many theories of how economics should be done? One would think that after centuries of trying different approaches, and seeing some practices obviously work, while others produce pretty dismal results, economists and investors should be able to say, “this is how money should be handled,” but disagreements continue. Why is that? I look forward to your answer.

BAHNSEN: I think that the assumption in the question is flawed, which is that economics is an empirical science that once we can merely see the actual empirical results, we can formulate consensus. But the reason you will always have differing and indeed, flawed view of economics, as you rightly pointed out, despite the testimony of history, is that economics flows out of anthropology. What I mean by that is, there are different views of the human person. There are different views of human nature, there are different understandings of what the human person is here on earth to do, human person's relationship to society, in my worldview, the human person's relationship to God. And all of these things are actually what formulate our view of economics. And so the reason we're going to continue to have different views of economics is that we have different views of anthropology. I don't believe that we would have Marxism, collectivism, Keynesianism, a heavy love affair with central planning, if everybody adopted Christian anthropology. I think a Christian anthropology would be a bridge to a more consensus understanding of economics, that then is anecdotally supported by empirical evidence. However, I don't believe that we're going to go to a period of uniform agreement on anthropology anytime soon. And therefore, this all at once answers your question why we have disagreement and restates the case for a properly formed view of economics, which is that it is rooted in the Creator/ creature distinction. And that theological truism formulates our understanding of economics and therefore, economic application. And along the way, our attempts to persuade people about certain matters of policy with empirical evidence can be anecdotally effective, but it's still trying to treat the symptom instead of the root problem. And when we treat economics or teach economics at root, at first principles, which is our understanding of anthropology, that's when we have a chance of getting this all right.

EICHER: All right, well, great questions this week too. Thanks to Sam Burnett and Paul Gebel. We love listener questions and if you have something on your, please get in touch at feedback@worldandeverything.com.

I’m happy to read your question if you just put it in writing in an email. But, I think it’s so much better to hear your questions in your voice. So if you’d take that extra step and make a voice memo recording of your question and email the file, so much the better. Same address: feedback@worldandeverything.com.

David Bahnsen is founder, managing partner, and chief investment officer of The Bahnsen Group. His personal website is Bahnsen.com, B-A-H-N-S-E-N. That’s how you spell David’s last name correctly and knowing that will get you to the right URL online if you want to see what David’s up to. Bahnsen.com.

David, thanks again, and I’ll look forward to talking next week.

BAHNSEN: Thanks so much, Nick.

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