For more than a generation, the price of money has been falling.
Since the inflation genie was put back in the bottle in the early 1980s, U.S. interest rates have been on a slide. The federal funds rate fell from a high of 22.4% in 1981 to nearly zero now. In fact, back in October, the government actually borrowed $10 billion via a bond issue at an interest rate of negative 0.55%. That's right: People actually paid for the privilege of lending Uncle Sam hard-earned cash.
Over the past 30 years, it's been an economic truth that credit has been and will always be cheaper. That encouraged people to borrow. Consumers offset stagnant wages and a higher cost of living by running up debt. The savings rate dropped from nearly 12% in 1975 to a low of 1.2% in 2005, while household debt swelled from 68% in 1977 to 128% of disposable income in 2007. (Both numbers have improved a bit since those lows.)
This helped finance the consumer-spending boom that drove the economy forward. It funded new industries and new jobs. On the downside, it encouraged two economic bubbles, in tech stocks and real estate. And it helped the government finance a steady stream of budget deficits, thanks to tax cuts, war expenditures, stimulus initiatives and economic bailouts.
But this era is ending as we roll into a global infrastructure and investment boom the likes of which we haven't seen since the post-World War II reconstruction of Japan and Europe.
Life without cheap money
This change will produce strains on the global financial system on a scale that hasn't been seen in 60 years.Many governments will be forced to address out-of-control budget deficits and unsustainable debt levels with higher taxes and austerity. Consumers will be forced to deleverage and cut spending. Investors will need to rediscover equities after a recent fascination with bonds. And businesses will need to do more with less capital.
But there are also many positives, including lucrative new opportunities for investors, especially in those companies set to profit from the modernization of the developing world. Banks are also set to do well as higher interest rates increase loan profits.
First, let's review how we got here.
Savings glut or investment dearth?
Economists have pointed to various causes for ultralow interest rates, which are a function of the supply of money (from savings) and the demand for money (from investment in productive assets). Fed Chairman Ben Bernanke suggested in 2005 that a "global saving glut" led by the likes of China was funneling excessive savings into the United States -- which helped inflate the housing bubble by keeping long-term interest rates low.New research by McKinsey Global Institute puts the blame on a lack of investment -- equivalent to $20 trillion over the last 30 years, the size of the U.S. and Japanese economies combined. Investment in infrastructure, housing, machinery and equipment fell from a peak of 26% of gross domestic product in the 1970s to a low of 20.8% in 2002 and just 21.8% now.
We can see evidence of this inadequate investment all around the developed world.
I've written about how the capital base of the United States is shrinking as businesses let their factories fall into disrepair. The American Society for Civil Engineers gave our infrastructure a "D" grade in its latest report card and estimates that we need to spend $2.2 trillion over the next five years to rebuild bridges, fix water supplies and upgrade our schools, roads and energy systems. The government estimates that while U.S. road use nearly doubled from 1980 to 2008, system capacity increased by just 8%. It's no wonder rush-hour traffic is so terrible.
It's not just here. In London, 40% of the city's water mains are more than 100 years old and 12% are more than 150 years old.
The other story is the emerging demand for new homes, factories, office towers, hospitals, shopping centers, schools and utilities across the developing world. McKinsey believes that if consensus forecasts of global growth are realized, worldwide investment will exceed 25% of GDP in 2030, or $24 trillion -- up from $11 trillion today.
Continue: The coming investment boom
