Economics: Making Sense Of The Interest Rate Rally

  (Drivebycuriosity) -  The interest rates are on a tear. What is the cause of the rally? Often interest rates climb when the markets expect higher inflation rates for years to come. But I think the recent jump of the inflation numbers, caused by the Iran War and leaping oil prices, is just temporary and does not justify a sustained interest rate rally. 

 

                  Helicopter Money 

We learned from Milton Friedman that "inflation is always and everywhere a monetary phenomenon". The money volume, the amount of money available in the whole economy, restricts how much people can spend for goods & services. If they - for in instance - pay higher prices for imported goods, then they purchase fewer of them or they spend less for other goods & services.

Friedman`s insight got confirmed by the recent inflation wave. It was caused by a deluge of money in the years 2020 & 2021. In 2020 & 2021 the government flooded the economy with stimulus checks in the value of trillions of dollars to fight the Covid19 recession (American Rescue Plan). The government checks got financed with massive bond purchases by the Federal Reserve (Quantitative Easing known as QE1,QE2 & QE3).

The government money landed directly on the bank accounts of the Americans, blowing up the money volume M2 (bank notes & coins & deposits at banks). Milton Friedman described this as helicopter money (cato ). As a result in 2021 & 2022 the US money supply M2, the engine of the inflation, jumped 40%. Unfortunately the money deluge met a constrained supply of goods & services partly - partly because of Covid19. So the price level inevitably had to jump and the inflation rate (first derivation) went up.

 

( source) 

But the money deluge has ended. In the recent months M2, the engine of inflation, grew just 4.7%. Simultaneously the US economy, represented by the GDP, advanced 1.6%. There is not much space for inflation.

 

                     Explosive Growth  

I believe that there is a better explanation for rising interest rates - the explosive growth of AI. “The buildout of AI factories — the largest infrastructure expansion in human history — is accelerating at extraordinary speed" (Nvidia CEO Jensen Huang cnbc). According to Huang the investments into AI could get up to $4 trillion annually ( cnbc).

These investments have to be financed of course. Google, Microsoft, Meta and the growing number of other AI investors need to take gigantic loans to finance
their investments. I think that the sharply rising demand for loans - to finance AI investments - is the propellant for the interest rate rally.   

I also suppose that the quick implement of AI will hike the productivity of the whole economy, raising company profits & accelerating economic growth. Rising profits and faster economic growth will make consumers & CEOs more optimistic and inspire them to take more loans. The rising costs of the loans, the interest rates, are covered by higher profits.

Apparently we have to get used to higher interest rates. Fasten seatbelts!