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For perspective, one can look back to a former Texas governor, who later served as Secretary of the Treasury
The Great Inflation was a macroeconomic period during the second half of the twentieth century. The Great Inflation lasted from 1965 to 1982. Simplistically-speaking, looking back quickly, at or around this time in American history, inflation in the United States had at times been blamed on “high oil prices”. Yet blaming “high oil prices” would be an inaccurate, overly-simplistic, assessment for inflation. At that time.
During the Great Inflation, credible arguments have been made that United States monetary policy had been designed to finance increasing (and potentially further increasing) annual debt levels. And annual deficits too. Those annual budget deficits (and debt levels) it can be argued, were a prime catalyst for the aforementioned noted inflationary cycle. The period of time in American history I am going to look at here might be considered one “shining light”, so to speak, found within this difficult inflationary period.
Debt, incurring additional debt, financing that debt, and then, potentially having unmanageable debt… Looking at debt management, outside of federal policy, two American policy architects - one during the period of the Great Inflation, and one a former United States President - had interesting personal experiences with “debt”.
Individuals - and businesses - may choose to utilize bankruptcy laws to their benefit when decisions, the market, or uncontrollable circumstances lead to a disadvantageous shift in financial conditions. Those changing financial conditions affect the servicing of debt.
As we know, President Trump utilized bankruptcy laws six times for his companies, prior to becoming president. President Trump was a noted proponent of a low interest rate environment, often speaking to how the Federal Reserve should maintain low interest rates.
Moving on from President Trump, one of our United States Presidents, a President who held office during the period of the Great Inflation, was Richard Nixon.
In 1971, President Nixon appointed former Texas governor John Connally to the position of United States Secretary of the Treasury. As Secretary, John Connally defended increases in the U.S. debt ceiling, viewing debt as a fiscal stimulus. While at the same time, presiding over policies which led to the dollar being devalued. Secretary Connally filed personal bankruptcy in 1986.
In 1971, 1971 being the year Secretary Connally was appointed as Treasury Secretary by President Nixon, the annual deficit of the United States totaled $23 billion. George Shultz took over as President Nixon’s Treasury Secretary in 1972. In 1972, the total federal debt of the United States held relatively steady, at $427 billion. While the federal deficit remained unchanged, at $23 billion.
The following year, the federal budget deficit of the United States fell to $15 billion under Secretary Schultz. By 1974, the federal budget deficit was further reduced to $6 billion, while the federal debt of the United States grew to $475 billion.
President Trump took office in 2016. In 2016, the total federal debt of the United States exceeded $19 trillion. That same year - 2016 - the debt of the United States totaled 105% of annual GDP. By 2020, President Trump’s last year in office, the federal debt of the United States reached $27 trillion - 129% of annual GDP. The debt-to-GDP ratio for the United States first hit 100% in 1945, at the end of World War II. From 1948 to 2014, the annual debt level of the United States remained under 100% of annual GDP, reaching 100% of GDP once again in 2014. The annual debt of the United States was 124% of GDP in 2021.
It is arguably rather difficult to project interest rate policy today, by merely looking back to this period of time that Secretary Connally, then later, Secretary Schultz, headed the Treasury. This is so because, at that time, the national debt of the United States did not exist as it does today. As such a large portion of annual GDP.
The debt of the United States, and the country’s budget deficits as well - both under the previous President, and under President Biden - are at relatively high levels. So, for perspective, integrating the period of the Great Inflation into this argument, one could look at the interest rate policy of the United States, set into motion by President Nixon’s Secretary of the Treasury, John Connally. Beginning in 1971. And continued onward, once Secretary Schultz took over for Secretary Connally, as head of the Treasury.
In 1971, the year Secretary Connally took office, the average yield on the Federal Funds Rates was 4.67%. The total debt of the United States in that same year of 1971 totaled $398 billion. And that $398 billion in U.S. federal debt made up 35% of annual GDP.
In 1972, the total federal debt of the United States was reduced to 34% of annual GDP, while the federal debt in 1972 increased to $427 billion.
What about interest rates? The Federal Funds rate remained steady in 1972…largely unchanged from the previous year.
The following year - 1973 - saw the federal debt of the United States, as a percentage of GDP, be further reduced. Total debt was reduced to 33% of GDP in 1973. This occurred, even as the total debt level of the United States rose to $458 billion (from $427 billion in 1972). In 1973, while debt as a percentage of GDP had been reduced, the average yield on the Federal Funds rate had increased substantially…to 8.74%. Interest rates rose.
By 1974, the average yield for the Federal Funds rate had reached 10.51%. The federal deficit by 1974 had been reduced to .40% of annual GDP - reduced from $15 billion in 1973, to $6 billion in 1974. Federal policy, it can be argued, was working very well at that time. A well-functioning federal fiscal policy, coupled to, increasing interest rates.
In 1974, the average yield on the Federal Funds rate reached 10.51%. A federal funds rate of over 10% will no doubt today be considered to be a “very high interest rate”. Yet no one that I have seen on news channels is referencing America’s fiscal policy at that time - a time of increasing interest rates. Kind of like today? And we use this time period, where Secretary Connally, then later, Secretary Schultz, headed the Treasury. This period of time within the the Great Inflation, since “inflation” was front and center then, just as it is now.
In 1974, the annual budget deficit of the United States had been reduced to $6 billion - under Secretary Schultz. Yet I see no one on news channels today celebrating the work of John Connally (nor Secretary Schultz). Nor using the financial engineering enacted by Secretary Connally, then later Secretary Schultz, as good points of reference, as interest rates rise today. Point being, fiscal policy is, to a large degree, a-political.
It’s difficult to pin fiscal policy enacted as being either “good” or “bad”, in and of itself, looking at only one element of the fiscal policy. Only one element, such as, interest rates.
A federal funds rate of 10% might be considered to be, "bad", correct? But what if that 10% federal funds rate is coupled to significantly reduced federal debt levels? And fiscal policy is often outside of the traditional talking points news networks like to focus on. Even though fiscal policy should be, arguably, Point “A”.
Debt, GDP, and the Federal Funds rate… So let’s look at the interest rates on 30-year fixed rate mortgages while Secretary Connally (and Secretary Shultz) served as Secretaries of the Treasury.
In 1972, the average interest rate on a 30-year fixed rate Freddie Mac home loan was 7.38%. The average yield on the Federal Funds rate in 1972 was 4.44%.
In 1973, the average interest rate on a 30-year fixed rate Freddie Mac home loan rose to 8.04%. The average yield on the Federal Funds rate in 1973 saw a sharp spike...to 8.74%.
In 1974, the average interest rate on a 30-year fixed rate Freddie Mac home loan increased further, to 9.19%. The average yield on the Federal Funds rate in 1974 increased to 10.51%.
In 2017, President Trump’s first year in office, the average Federal Funds rate was 1%. In 2017 - President Trump’s first year in office - the average interest rate on a 30-year fixed rate Freddie Mac home loan was 3.99%.
In 2020, that Federal Funds rate averaged out to be a uniquely-low .36%. In 2020, the average interest rate on a 30-year fixed rate Freddie Mac home loan was 3.11%. The total federal debt of the United States was $27 trillion in 2020 - lots of federal debt. And families took on relatively high levels of mortgage debt at this time too...facilitated by the uniquely low mortgage rates. By the end of 2021, the federal debt of the United States grew further, to $29 trillion.
So what is going to happen with interest rates going forward?
It is arguable that the low interest rate policy we just went through drove house prices to levels which are, arguably, unsustainable. These high home prices make it quite unaffordable for many first time home buyers. Those who purchased homes during this period of time? They still benefit from the low interest rates they are locked into…even at the high debt levels they have. Even if their homes do decrease in value (somewhat) going forward. Financing debt, financing deficits…each is made more doable, in a low interest rate environment. The country has a high amount of federal debt. Americans have high levels of mortgage debt.
So going forward, what happens with interest rates?
Can or should the national fiscal policy of the Fed continue to subsidize home sellers by serving as a proponent of low interest rates? Low interest rates, which in turn, lead to a correlated unsustainable increase in prices of homes? One could credibly answer, “no” to that question. So then let’s look back to Secretary Connally (and Secretary Shultz) once again.
The total federal debt of the United States was reduced under Secretary Connally’s watch. Annual deficits for the United States also decreased under Secretary Schultz's time serving as Secretary of the Treasury.
Interest rates? Interest rates rose at the same time. Both during Secretary Connally's watch, and during Secretary Schultz's watch. But today, things do look quite different.
Debt levels of the United States today…are continuing to increase. Coupled to increased government spending. Coupled to, increasing interest rates. And this is where the reference point for future projections, using Secretary Connally and Secretary Shultz as examples, fractures, and becomes rather difficult.
Under Secretaries Connally and Secretary Shultz, annual deficits went down, as interest rates went up. Today? Interest rates are rising, and debt levels are rising too. And federal debt levels rose under each of the previous two Administrations...be it an Administration with a "R" heading the Administration, or be it an Administration with a "D" heading the administration. Fiscal policy, in this regard, is a rather a-political topic, one can argue.
So what about the real estate market?
Looking at values and prices of homes today (they are high), looking at federal debt levels today (they are high), looking at federal deficit levels today (they are high), it is an arguable point that interest rates could (and should) continue to rise. Ideally, with less debt incurred, and with deficits reduced. Might not happen.
If interest rates do continue to rise (they likely will) then would we be looking at a foreseeable fiscal environment where home prices decrease - then level off - while we adopt an acceptance of a “higher interest rate” environment? Then once again, looking at the “fiscal house” of the United States under Secretary Connally (then later under Secretary Shultz), such a transition to higher interest rates would not be deemed to be “bad” for the United States, overall, correct? The caveat here being, what about the debt? What about the deficits?
It’s great to have a great home - with a high mortgage balance - at a super-low interest rate. That works. Add a car loan in to the equation, with a higher interest rate. Add in some credit cards, with higher interest rates too. Then all of a sudden, the awesome home with the low interest rate is merged in with other high interest rate debt, which has to be serviced as well.
Therein lies the potential challenge we all face, as the interest rate environment changes. Taking fiscal policy into account - individual family fiscal policy, and macroeconomic national fiscal policy - as we consider our new American fiscal climate.