Negative Interest Rates in America?

Back in October, I wrote an article titled “How Will We Deal With All The Debt?” Here’s an excerpt (emphasis mine):

The federal government’s deficit for 2019 should come in around $1 trillion. That’s the equivalent of about 5.1% of our gross domestic product (GDP). And it will push the total federal debt to more than $22 trillion.

So we’re 10 years into this bull market, yet we’re annually adding debt equal to 5% of the entire economy. That’s crazy.

What will happen during the next recession? The deficit could easily climb to $2 trillion or $3 trillion.

It appears that my estimate of a $2 trillion to $3 trillion deficit during the next recession was too conservative.

The Congressional Budget Office (CBO) just predicted that the U.S. federal budget deficit will hit $3.7 trillion for fiscal year 2020 (the fiscal year runs from October 1st to September 30). And if history is any guide, the CBO’s estimates are likely optimistic. 

Such a large increase in debt will have a number of consequences. One of the most worrying is the increasing likelihood of negative interest rates. 

Billionaire “bond king” Jeffrey Gundlach recently expressed his concerns about negative rates on Twitter

These Trillions Treasury is borrowing is heavily in T-Bills. Chair Powell has stated in plain English he is opposed to negative interest rates. Yet the pressure to go negative on Fed Funds will build as short term borrowing explodes and dominates.  Please, no.  Rates < 0 = Fatal.

Gundlach is deeply concerned about the impact of negative rates, which he says could be “fatal” (to the economy). 

Investing With Negative Interest Rates

In his annual shareholder speech, Warren Buffett addressed the possibility of negative interest rates. And he didn’t sound enthusiastic about it.

“If they’re going to be negative for a long time, you better own equities or something other than debt,” Buffett said.

His comments are concerning, especially considering that the debt (bond) market is far larger than the stock market.

I believe Buffett is concerned about the increasing possibility of inflation. Many of us believe that owning equities (stocks) will be far preferable to bonds if we see sustained inflation. 

If inflation ends up running at 10% a year and a bond pays you 2%, you lose 8% a year in real terms. And then you have to pay taxes on the 2%. High quality stocks with pricing power should fare better.

This resilience is likely one of the reasons stocks are doing so well (for now), despite the harsh economic reality on the ground. High quality stocks are seen as far better alternatives to CDs and savings accounts.

And as I’ve outlined many times before, I believe that inflation is the “path of least resistance”, and is by far the most likely outcome of this mess. Here’s how I phrased it last October:

As I see it, we have very few options…

  1. Raise taxes dramatically.
  2. Cut government spending by 40%.
  3. Erase the debt with inflation.

I believe the powers that be will choose No. 3.

Today, with the COVID-19 crisis set to impact growth for an unknown amount of time, I believe the choice before policy makers is even clearer. Inflation is the only real option. If the Federal Reserve thinks negative interest rates are going to help get us inflation, I think they’ll try it.

Of course, we don’t know if negative rates will actually increase inflation. We also don’t know which assets they will end up affecting most (stock prices, wages, or food prices). We’re witnessing the largest monetary experiment in history.

Challenging Times

I’m fairly certain that the next decade will be one of the most challenging investment environments most of us will ever see. Unprecedented debt, low interest rates, and massive government intervention will make it tough to navigate.

Personally, I think it’s more important than ever to have exposure to emerging market stocks, gold, silver, startups, and bitcoin. These are all assets that have the potential to perform well in chaotic economic and monetary times. They are my preferred hedges today.

I realize that I’ve been hitting these points hard over the last year or so. But there’s a reason for that. I believe the game plan that worked so well for the last decade is unlikely to be as effective going forward. Owning the S&P 500 isn’t enough today. It puts too many eggs in one basket. 

Whatever investment strategy you choose, I continue to believe it’s important to buy and hold for the long term. Trying to time any market today is just about impossible.