Photo by Jen Theodore on Unsplash
Hello,
Welcome to Known Unknowns, a newsletter that is wary of soft landings that land on quicksand.
Soft landing in sight?
I am a chronic worrier about inflation and interest rates. I can’t help it; I am a Pension Geek, and these variables are a major source of risk. I spent lots of time looking at their history and assumed the happy low-rate/low-inflation world of 2019 couldn’t last. And so, even when it was not fashionable, I was worried and, in retrospect, did not always need to be. So, when higher rates and inflation came back, I was prone to think, “Finally, I was right!” and feel vindicated.
But, as of last week, it seems lots of smart people look at the data and see a return to the 2019 world. Now, not all team soft-landing people go that far; to some people, it just means low inflation and unemployment, but they have no view on how long these things last.
But, based on markets, it seems some people are in the we-go-back-to-2019 camp. Really smart economists are arguing that low rates and low inflation are structural to the economy. And that suggests, thanks to some good luck and excellent Fed policy, that soon this whole rising price nightmare will be behind us.
And who knows? Maybe we do live in a different world, and a thousand years of interest rate data tells us absolutely nothing about today. Maybe we do live in a world where financial and price risk is negligible because of technology, global integration, or because we are just older and smarter. If so, a soft landing is not just a place to land but a place where we stay, and where we stay is honestly more important than where we land. I hope that’s the case. It would be good for everyone.
Perhaps it’s my bias, but I don’t think this is where we are going, and a bad surprise will be costly for everyone, so it’s worth exploring. Ken Rogoff explains here why even if rates go down, they will go up again. And I am also concerned we may be in a more volatile inflation environment. Inflation was so low for so long, no matter what we did, because we experienced a 35-year-long deflationary supply shock, otherwise known as trade with China and Mexico. And even if we don’t deglobalize, labor in these countries is getting more expensive. Or, at the very least, it certainly seems we are in a riskier macro environment, and how can that not increase term premiums?
My point is, rate cuts or not in 2024, we aren’t going back to 2019. But I could be wrong.
Pity the Gen Zers
They have had it rough. Their education was interrupted by COVID, and I don’t know how they will afford to buy a home any time soon. We spent years hearing that millennials could not buy real estate because of student debt. This is in spite of the fact that there’s a positive correlation between student loans and home ownership (because college graduates are more likely to be homeowners). And they had a point; houses were more expensive (and bigger too). But the Millennials also had super cheap mortgages, especially during their prime first-home-buying years.
Now, among household heads, millennials have similar ownership rates to what boomers had at their age. The important caveat here is that millennials are less likely to be head of a household: only 47% of all millennials were homeowners in 2022, compared to 54% of boomers in 1989. But the difference there comes largely from non-college-educated males who have not yet formed their own households. These are issues that go beyond house prices.
In any case, rates and prices are now up, and the housing market will be weird for a decade or so, since no one will move if they don’t have to. That leaves poor Gen Zers shut out of the market. So, if anyone has a reason to complain, it will be them.
Wealth taxes, legal or not, they are a bad idea
There is a big Supreme Court case about when unrealized capital gains are actually income. I am not a lawyer, so I don’t have a strong view on the legal merits of the case and whether it is really income. But I bring it up because the outcome is presumed to be a judgment on whether unrealized gains can be taxed at all. Again, not a lawyer, but as an economist, the answer is no. Not only are wealth taxes the most inefficient of all taxes, but the whole idea should be a non-starter because measuring wealth is so hard. You can’t tax what you can’t measure. And the logistics of unrealized gains is a nightmare.
We do need more revenue—unless we want to be taxed the other way—i.e., through inflation or higher rates (another reason why I am still worried). But there are better and even more progressive ways to do that.
The economy/world is getting real. We really don’t have the luxury of bad policies anymore (though we’ll still get them).
In other news
Life expectancy is not declining, though there are problems.
Both corporations and universities recently learned the hard way that they should stay out of political issues that don’t concern them. And I hope they do, for all our sakes. But labor unions didn’t get that memo. Several big unions, including UAW, just called for a cease-fire for Israel (but not Hamas). I don’t think unions are the best fix for the economy, but the fact that they are taking overt political stances on issues unrelated to labor isn’t helping their cause.
Until next time, Pension Geeks! See you in the New Year!
Allison
The most interesting graphs I have seen recently show the effective mortgage rate of homeowners (less than 4%) and the interest paid by corporations. Both groups realized that there was a window of opportunity in 2020-21 to lock in historically low rates and took advantage of it. As a result, the fastest interest rate hike in US history results in a large wealth-weighted percentage of consumers and corporations largely unimpacted by the interest rate increases (I am one). If we have a soft landing, that is likely to be the key reason. People and businesses living and dying by rapidly changing interest rates are going to get hit hard, but they are likely to be marginal to much of the economy unless CRE really blows up when it refinances. I note that I have had mortgages with rates ranging from 18% to 2.6% over the past 40 years, so I look at current mortgage rates available to buyers and view them as "normal".
With inflation still over the 2% target, I expect that the Fed will be keeping the Fed Funds rate higher than Wall Street thinks for longer without a likely return to the very low rates of the 2010s and 2020-21 in the next few years. I think the biggest question for 2024 is how the yield curve resolves itself? A negative yield curve of 1% or more is not normal at all. Are we in for another odd long period of time with a negative yield curve instead of the the unusual ZIRP policy that dominated for a decade?
Unemployment under 4% and GDP growth over 2% does not scream Fed Fund rate cut, but long bonds are behaving like we are in a recession. Fed Fund of 4% with a 10 year rate of 5% would be historically normal. Neither show an inclination to be at such a normal condition. I tend to believe long bonds over the stock market and Fed Funds rate, but both Fed Funds and long bonds have been manipulated by the Fed for so long, it is not clear what economic signals exist in either right now.
Would love to hear what the smart folks think about the costs of onshoring