This piece makes a case for the Federal Reserve (FED) to cut interest rates. The report discusses various parameters that impact consumer spending, the structural fundamentals of the economy, and why a small FED cut—a change would do you good—would be beneficial.
Sheryl Crow has been one of the most defining artists over the past couple of decades. With excellent vocals and showmanship, Sheryl’s songs encompass a genre of rock and pop that influences millions of fans globally. Her songs touch on issues that resonate with common people. “A Change Would Do You Good” is one such single that nudges people to embrace change as a part of life. It’s time for central banks, including the FED, to reexamine the inflation target and for the FED to adopt a more dovish stance on inflation and make the first small interest rate cut. The low employment rate and high consumer spending, as highlighted by the low personal savings rate, have been a hindrance for the FED to reduce rates. High borrowing costs and rising prices in both the residential and commercial segments are causing significant problems for small businesses and millennials attempting to purchase homes. Abolishing student debt and open border policies not only increases inflation but has further divided an already polarized nation. Apart from economic and financial reasons, a rate cut will a small but decisive step in uniting a disunited nation.
Global and US Debt
The global debt has increased significantly over the years. According to Institute of International Finance the global debt including households has crossed $300 trillion. UNCTAD estimates global public debt to be $97 trillion in 2023. Based on the OECD Global Debt Report 2024, the total global debt of sovereign and corporate debt stood at $98 trillion in 2023. This increase in debt is 139.02 percent over the debt in 2008. The sovereign debt, which is the major component of total debt at approximately 65.3 percent, increased by 146.15 percent over 2008. The corporate debt increased by 126.67 percent over the same period. The majority of the sovereign debt over this period is held by advanced countries, primarily due to the pandemic crisis. According to the OECD report, total OECD government bond debt is estimated to grow to $56 trillion this year, an increase of $30 trillion compared to 2008. Between 2008 and 2022, interest rates were low, but rates increased due to inflation caused by monumental fiscal measures and supply chain disruptions.
Fed Funds Rate
Chart: Board of Governors of the Federal Reserve System (US), Federal Funds Effective Rate [FEDFUNDS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/FEDFUNDS, June 7, 2024. Percent, Not Seasonally Adjusted; monthly
However, in a high interest rate scenario, the situation becomes troublesome as within the next three years, 40 percent of the sovereign debt and 37 percent of the corporate debt is maturing. The OECD Global Debt Report 2024 estimates that even if central banks bring inflation down to the target of 2 percent, yields will remain higher compared to the low interest rate era.
Total Global Debt
The U.S. economy has accumulated a significant amount of debt. In March 2024, U.S. debt reached $34.47 trillion. With high interest rates, the interest burden on U.S. debt is becoming unsustainable. According to Visual Capitalist, at current interest rate levels, the U.S. national debt is growing by a remarkable $1 trillion approximately every 100 days, equivalent to roughly $3.6 trillion per year. High government debt, combined with a low personal savings rate—which stood at 3.6 percent in April 2024—further exacerbates the pessimistic economic outlook. Ongoing geopolitical risks, such as wars, the rise in protectionist policies, high oil prices, and deglobalization, need to be balanced by strong fiscal measures. Policies taken by the U.S. government have led to higher borrowing, further fueling inflation risks. The cost of the pandemic has been high for U.S. consumers. It has led to increased consumer spending, offset by high inflation, resulting in reduced real purchasing power. The US federal response to the COVID-19 pandemic in 2020 and 2021 amounted to $4.2 trillion in debt, which is about 19 percent of the pre-pandemic 2019 US GDP. 1
Data Source: OECD | Global Debt Report 2024 | Chart: The middle Road
Note: Gap – the difference between sovereign and corporate debt
Consumer Spending – A look at the Bigger Picture
“Deloitte survey shows Gen Z Americans are three times more likely to get caught up in online scams than boomers are.”
Consumer spending in the American economy has been robust. Consumer spending, or personal consumption expenditures (PCE)—a variable closely tracked by the FED—is the value of goods and services purchased by or on behalf of U.S. residents. PCE grew by 0.2 percent in April this year (excluding food and energy prices). PCE has grown consistently this year, suggesting strong consumer spending. Americans have a low savings rate and a high propensity to consume. In 2024, household disposable income in the US is expected to be about $21.09 trillion, with total consumer spending projected to be $19.56 trillion.
The Middle Road recommends that policymakers nudge consumers to save more to increase the savings rate, thereby reducing the PCE component of inflation. Rather than keeping interest rates high, encouraging consumers to save by limiting the consumption of non-essential goods would be one of the most pivotal initiatives in bringing down inflation and government debt over time.
However, there are some indications that inflation might come down. The unemployment rate is slowly climbing up and stood at 4 percent in May. It has been steadily increasing since March this year after a surprising dip in March following an increase in February. The rising unemployment rate might be influenced by various factors, including technological advancements such as artificial intelligence. According to the latest data shared by the U.S. Bureau of Labor Statistics, total nonfarm job openings decreased to 8.1 million in April, down 296,000 from March’s downwardly revised 8.4 million. Although hires were little changed at 5.6 million, unemployment is increasing in the US. Nonfarm jobs provide an excellent understanding of the labor market in the US; a decrease in nonfarm jobs suggests less vibrant activity within the economy.
Total Construction Spending
“The survey covers construction work done each month on new structures or improvements to existing structures for the private and public sectors.”
Chart: U.S. Census Bureau, Total Construction Spending: Total Construction in the United States [TTLCONS], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/TTLCONS, June 7, 2024. Percent Change, Seasonally Adjusted Annual Rate; monthly
S&P CoreLogic Case-Shiller Index a Lag Indicator for Recession or Consumer Spending
Chart: S&P Dow Jones Indices LLC, S&P CoreLogic Case-Shiller U.S. National Home Price Index [CSUSHPINSA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CSUSHPINSA, June 7, 2024. Index Jan 2000=100, Not Seasonally Adjusted. Frequency Monthly.
Check out the online courses to know more about Case Shiller and other indicators.
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Building Green Energy Ecosystem
According to the International Energy Agency (IEA), global annual renewable capacity additions increased by almost 50 percent to nearly 510 gigawatts (GW) in 2023, the fastest growth rate in the past two decades. The IEA estimates that China will have almost 60 percent of new renewable capacity expected to become operational globally by 2028. In 2024, IEA estimates the total global energy investments will exceed $3 trillion with a lion’s share of $2 trillion in clean energy technologies and infrastructure. According to IEA, World Energy Investment 2024 China is by far the biggest investor in clean energy. Outside, the three mentioned countries, India is a major investor in clean energy.
Investments in Clean Energy in $ billion
Today, China dominates the solar and battery market, while the EU is innovating through wind energy. Among the clean energy sectors, solar PV is the biggest segment at $503 billion, nearly a bit more than 18 percent higher than other clean energy investments. China is leading the way with the largest gain in percentage in clean energy, followed by advanced countries. America, despite having the first-mover advantage within the green energy sector due to some visionary policies taken by Jimmy Carter, has not been able to capitalize on this advantage. The European Union and China have overtaken the US in innovating clean technologies and navigating consumer behavior towards sustainable energy.
Data: World Energy Investment 2024 | Chart: The middle Road Note projected investment amount in 2024 – Note the $billion and project investment are added after initial publication of the read.
According to Renewable Energy World, the $112 billion battery market is expected to grow by almost 400 percent, reaching $546 billion by 2035. But this figure can be achieved much sooner as the IEA expects $50 billion of investment in the battery market this year alone. The EU implemented the first carbon pricing mechanisms, especially exchange-traded emissions; China implemented the largest in the world. However, in comparison, America’s impact in this sector is limited. Although the United States, particularly California, has also implemented its own Emissions Trading System (ETS), known as the California Cap-and-Trade Program, comparable to the cap and trade implemented by the EU, and policy initiatives by the US government have helped in the promotion of the green sector, the impact is not uniform. Recharging stations are one of the key pillars of a world-class electric vehicle ecosystem, and they are found wanting in states like California, which is one of the earliest adopters of renewable energy. Today, China has the largest solar farm in the world; it’s noteworthy that the novel concept of a solar farm was invented in California, US. As protectionism rises globally, The World Bank has estimated that governments globally are increasingly deploying increased subsidies within the green energy sector. The key focus areas are clean technology and faster adoption of renewables. China and the United States lead as givers of the subsidy programs, followed by Australia, Canada, and the European Union. The proliferation of electric cars is driving increased investments in EV adoption along with climate initiatives. By investing in clean energy technologies, better solar power technologies can emerge and be scaled, generating higher margins. As economies of scale rise, clean energy technologies become much cheaper than fossil fuels and emit no greenhouse gases. These technologies are replicable in other countries, fitting the energy gap among emerging and frontier technologies. For example, Multilaterals like IFC are transforming clean technology for countries in Africa. By increasing the quantum of investments, the US is negating any price shocks due to high oil prices while maintaining a sustainable future. The vast startup ecosystem in the US can facilitate a technology wave among startups.
Wrapping Up
Over the last few years, the world has become more polarized. Extreme leftist policies, especially among advanced countries, include instances of drag queens at schools and the promotion of sex changes among men, which have incited outrage. Additionally, there has been a rise in sometimes violent protest rallies and, at times, outright insults to home nations, especially due to the ongoing Israel-Gaza war. These events have led to the rise of extreme right-wing activists. Instances that undermine the tenets of Christianity and the mainstream crisis of migration have exacerbated the situation. As migration becomes a critical issue among many advanced countries, and protectionism reaches a high, the presence of high inflation and borrowing costs will lead to continued discontent within societies. It’s time for central banks to re-evaluate their target inflation rates and reset policies that allow for moderately higher inflation. It should be noted that a brief cut in interest rates must be balanced by a moderation of both fiscal and monetary policies. The road ahead is not easy. If the US needs to come out of the debt problem, there has to be a sustained effort to increase savings rate, reduce fiscal deficit, implement policies that promote austerity, build an ecosystem of green energy and re-look at higher targeted policy rates. “In 2023, the US government had a budget deficit of $1.7 trillion. In the last 50 years, the US government was in surplus in only 4 years.” # With many countries following quantitative tightening, funding for further deficits will lie on corporates and households, which looks difficult. Prudent spending and increase in taxes are better viable options.
The US, the “Godzilla” among nations with “Godzilla” debt. With looming credit card debt, the debt in America is increasingly becoming unsustainable. In this civic and moral outrage, there is a sanguine outlook – a small rate cut that might unite all sides.
There is a famous saying: “If America sneezes, the world catches a cold,” and global debt, especially in the US, has dangerously crossed the red flag, waiting to explode with the clock ticking. Tick. Tick. Tick. A small interest rate cut.
References
- 1. https://www.ncbi.nlm.nih.gov/pmc/articles/PMC9111865/
- Bureau of Economic Analysis
- https://www.bea.gov/data/income-saving/personal-saving-rate
- https://www.oecd.org/finance/global-debt-report/
- https://www.census.gov/construction/c30/c30index.html
- https://www.statista.com/outlook/co/consumption-indicators/united-states#:~:text=The%20total%20consumer%20spending%20in,US%243.87k%20in%202024.
- https://www.iea.org/reports/world-energy-investment-2024/overview-and-key-findings
- #https://fiscaldata.treasury.gov/americas-finance-guide/national-deficit/
“The Case-Shiller Home Price Index, a benchmark for tracking changes in residential real estate prices, is a lagging indicator for consumer spending. As it reflects historical data on home prices, it helps to understand past consumer confidence and spending patterns. Declines in the index often follow reduced consumer spending and economic downturns, making it a valuable tool for analyzing the impact of economic changes on consumer behavior rather than predicting future trends.” Chat GPT name added later.
Note: By error twin deficit was mentioned as fiscal and monetary instead of fiscal and current account. The error has been corrected.
Total Construction Spending is a not a lead indicator, the error has bene corrected.
Disclaimer: It is important to note that this document contains information and projections set in the future (up to 2024). As such, some of the data, reports, and events mentioned are based on assumptions about future developments. The accuracy of these projections cannot be guaranteed, and actual outcomes may differ from those described in the document. Moreover, while the document presents a case for a small interest rate cut by the Federal Reserve, it is essential to recognize that this represents the author’s opinion and analysis. The decision to change interest rates is ultimately made by the Federal Reserve based on a comprehensive assessment of various economic factors and their mandate to promote maximum employment, stable prices, and moderate long-term interest rates. This report is for informational purposes only and should not be construed as financial or investment advice. The data and analysis presented herein are based on sources believed to be reliable, but we make no representations or warranties, express or implied, as to the accuracy, completeness, or suitability of the information. Readers should exercise caution and consult additional sources when making decisions based on the information provided in this document. It is always advisable to seek professional advice from qualified financial experts or institutions when making investment or financial decisions.
