#1004 - Can Rates Come down Before the Economy Hits a Wall? | With Ben Miller

0:09Can rates come down before the economy hits a wall? Hi, everyone. Welcome to the Real Vision Daily briefing. With me today is Ben Miller, founder of Fundrise. Hi, Ben. It's great to have you back on with us. Yeah, thanks for having me. So not a whole lot of movement today. Stocks were kind of flat. Even with the wobbles this week, though, S &P putting in its best Q1 since 2019. But it seems like a lot of people are wondering if that can continue. But we did have crypto up, gold up, the dollar up. And interestingly, bond yields also were moving higher ahead of the PCE inflation reading on Friday.

0:44Of course, that's going to hit when a lot of market participants are out for the Easter holiday. But Ben, we wanted to maybe pull the lens back a little bit because there's been a consistent theme that's emerged, I would really say, just in our conversations recently, maybe last week, definitely this week. And that is the risk that maybe the Fed doesn't ease this year at all, and that US rates are headed higher, not lower. And if that's the case, what does that mean? And it doesn't seem like the market's ready for that. And I know that you've been thinking about this a lot. I wanted to ask you about it because of your unique perspective, given that you invest in the commercial real estate market and tech, you're sort of on both sides of markets that would be really impacted by that.

1:33And then in the lead up to today, You shared this amazing deck that you sent us. And we just thought maybe as a treat, if you would be willing to share it with our audience, because it just tells such a great story of how you're thinking about this, because it's the trillion dollar question, the multi-trillion dollar question, it seems to me. Yeah, I went out and did some research because I've been confused by the economy. And I was surprised, maybe even shocked by what I found. and so then I started to try to pull it together into a deck because best way to think something through is by actually writing it down and so I I feel like I found a piece of data that's that opened my eyes to the to I think how things might play out that I hadn't seen anywhere else like really I mean it's just it seems like it should be everywhere I hadn't seen it anywhere and so I thought, oh my God, this is so interesting.

2:32Like I sent it to you. I mean, we finished the deck last night. I said, well, people need to see this. I know we were like, wait, this is so good. We want to share this. So we don't usually do this everyone, but I think that this is the kind of stuff usually you only get if your institutions or your, you know, really high level investors. So we're so appreciative that you're willing to do this with us, Ben. Just so you know, everyone, We're still going to do questions, but like, let's have Ben walk us through his thinking. And then as you're listening to him, think about the questions that are coming up in your mind, because as Ben pointed out, um, it's kind of a unique perspective and people are going to push back and, you know, usually already people kind of challenge you on some of it, I think Ben.

3:13So think about what your questions are or what you're wondering about. And then we'll do that at the end. But Ben, tell us, tell us how you're wrapping your head around this. Walk us through it. okay well so um can i share the deck now yeah yeah please okay is it is so basically i call it the race against recession because the the i think the underlying uh challenge in the u.s is that we have high debt loads everybody knows we have a lot of debt and and basically that our chance of succeeding is to grow our way out of that level of debt uh but let me let me just sort of like walk everybody through this argument.

3:50So let's start with the question of how much debt is there in the United States?

3:58And I hadn't actually seen anybody to put all U.S. debt into a single number, which is$96 trillion. This number comes from the Fed. So the St. Louis Federal Reserve will talk about total U.S. debts. And this includes government, both state and local and federal, home mortgages, household debt, business banking. So this is$96 trillion. So basically, if you think about America, America has$96 trillion of debt as of Q3 2023. Okay, so here's my question for everybody. So in which period did U.S. grow debts faster? The last 15 years, from 2008 to 2023, or in the 1990s? So the 1990s, great growth period, internet bubble, internet boom, the Berlin Wall came down.

4:47Or that's a 10-year period. Or in this last 15-year period, when we had the Great Financial Crisis and the pandemic stimulus, so which period had more U.S. debts grow faster? And the interesting thing is that the 1990s, debt grew at twice the rate. We actually had accumulated twice as much debt in the 1990s as in the last 15 years. And so that was shocking to me because I felt like the narrative is that there's all this debt accumulation, especially since the 2008 financial crisis. And then if you look at the debt growth rates, actual debt growth rates in America have been declining. It was actually even higher in the 80s.

5:30and it really leveled out since the Great Financial Crisis. And so you actually have two eras. You have this era before the Great Financial Crisis when debt growth exploded. You basically had the amount of debt in America grow by 5.6 times compared to GDP. And then it actually leveled out. So debts had been growing about the same rate as GDP since the Great Financial Crisis. And so that is completely contrary to the narrative. So if you go really into the numbers a second here, just because I feel like there's a lot of numbers here. Bear with me. But if you look at the far right, when you think about somebody who buys a house, the question the mortgage broker will ask is, what's your debt to income ratio?

6:21What's your DTI? And so the U.S.'s debt-to-income ratio actually has been improving since the Great Financial Crisis and has come down. So we've actually made progress on debt, which is just mind-blowing to me because I would have thought that the opposite is true. Okay. So I'm teeing this up because here we go. There was an exception. The exception was the 2008 financial crisis. And that crisis, there's a lot of narratives around it. But one narrative I think that I hadn't really appreciated is that we've grown these debt loads to very high levels. And then we've raised interest rates. So from 2003 to 2006, the Fed raised interest rates from 1 % to 5.5%.

7:12So that sounds very familiar to today. Interest rates went up, a lot of debt load. And so basically you have all this debt and it repriced to higher mortgage rates, higher interest rates. And so the debt to income in the United States skyrocketed. And I think that was a big contributor of why there was a financial crisis. So, OK, having said all that, basically looking forward, the question people ask me is, what does that mean looking forward? and I call it the great deleveraging, but the big thing happening in the world today is we went from a zero interest rate environment to a much higher interest rate environment.

7:55And that transition has been surprisingly smooth. And I basically think that we shouldn't get too complacent because there's been a good reason. The reason it's been smooth is that all of that debt takes time to reset to new rates. So the average duration of all U.S. debts is about six years. You know, home mortgage is longer and businesses will short. Bank debt is much shorter. Most banks are basically deposits. And so it's sort of this average duration. So basically, it's going to take six years approximately for most U.S. debt to reprice from a ZERP environment, from zero interest rate environment, to higher for longer.

8:40And that's why there's been this delay. So if you look at this thing, there's been this delay in the, well, let me go back. There's been this delay. And the reason there's been a delay is that basically most of the costs, the consequences of high interest rates haven't hit most Americans, most businesses, most businesses. And so, okay, so now having said that, the question is basically take this idea of a soft landing, which is the Fed's forecast. The Fed has a forecast for a soft landing, basically where the interest rates go from five to four to three to two, right? Over the course of from now to 2028.

9:20So over the course of a few years, everything moves gradually. Now, I take that forecast. So, OK, let's just take the Fed's forecast, accept the premise, and sort of apply it to the United States. And so over the course of that period, basically, the cost of debt service is going to increase by 50 % as all the debts in America slowly but surely reprice. And this is the punchline, this slide, because as every loan comes due and it reprices to the new higher interest rate, you pay higher mortgage payment or higher debt service. And so debt service in America was a little under$4 trillion in 2022, and it's going to go to close to$6 trillion.

10:12So 50 % more debt service or 50 % higher cost,$2 trillion. And so that, I talked to somebody about it yesterday, and they were saying like, well, what does that mean? I said, well, let's just think of you as a person. If you all of a sudden your mortgage rates and your credit card debt went up by 50%, what would happen to you? You couldn't afford it. So how does the country afford$2 trillion more of debt service? And just to put that in perspective, well, here's the phrase I'll go put in perspective. Okay, sorry, there's a lot here. There's a lot in this deck. We can come back to the slide. Late on us, Ben.

10:54Okay. Okay. I know tables of numbers can be hard for people. So I just wanted to, but I like to show my work. And basically what this is saying is that as they lower rates and we have a soft landing, we also, debt growth in America, we do grow debts. I'm saying, I'm forecasting a 5 % debt growth and it slowly resets. This middle thing, percentage of debts that reset, right? And so the debt service increases because the amount of debts increases and because of debt service and because of interest rates. Then GDP is growing. You end up at this period right in 2026, when you have high debt to income ratio, high increase in the amount of debt service, which is 2 trillion more.

11:43That's the soft landing. That's a soft landing. People are now saying no land. right? So no landing is higher for longer, even longer than what is in the soft landing forecast. So here are the three scenarios, right? There's the bottom one is no landing, the middle one is soft landing, and then the top one is low interest rates. And you just see the amount on the far right, right? The amount of increase in debt service and the amount of sort of the debt to rate debt to income ratio i mean it skyrockets so if we have a no landing scenario right where interest rates are higher forever basically i mean and people say oh five percent fed funds not that high they weren't they weren't that high when we had low debt ratios now that we have 100 trillion dollars of debt is a totally different ball of wax so like just to put that in perspective, how much is$1 to$3 trillion in additional annual mortgage payments or annual interest payments?

12:48It's all retail trade in America for a year. All manufacturing, all the GDP of the entire manufacturing sector, we have to go to pay this additional higher interest rate. You're liquidating on Amazon every year, on NVIDIA every year, just to pay this higher interest. So this is, this is what normally causes a slowdown in the economy and caught or causes a financial crisis because country can't afford that, but it hasn't happened yet because of that higher, that, that lagging time to reset the rates. So just to go back, let me just go back to this thing, right? Yeah. We don't, you don't see it hitting the sort of peak cost until 2025.

13:35Right. And by then, actually, rates are coming down. And you see that rates, the total amount of debt service actually goes to$2.25 trillion increase, even though rates have been falling for almost two years. So it's such a lagging. It lags on the way in, but this is the problem. It lags on the way when rates are going lower. That's still, you still have that line above the other one. That's the problem. Hey, everyone. We're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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15:57Choose between a tax-advantaged gold IRA or have physical gold delivered to your door. Noble Gold Investments ensures a seamless and easy transaction. Invest in something you can hold. Go to noblegoldinvestments.com slash vision to get started. Don't wait. That's noblegoldinvestments.com slash vision. Right. So you see basically the lag on the way in and you see the lag on the way out. And so that's basically the I can talk about sort of like, what can we do about it? But the essential argument and the essential challenge we have is. How do we how does America have an economy that's still growing at healthy rates and paying two trillion dollars more in debt payments that typically right?

16:48If you're a person or you're a company, you can invest in innovation, technology, education. You're like, oh, I can't afford to do that because I have to pay higher debts. I have to pay my interest payments. So it usually slows down growth. And I'm seeing here that although it hasn't happened yet, I mean, this is the math. Yeah, we're kind of dead man walking. I mean, it hasn't happened yet, but it's coming. You know, I got excited in the beginning because I thought there was hope. We all got that question wrong and that the 90s had higher growth. I'm sorry, higher debt levels, but it didn't kill us then.

17:27Is there a lesson in that? Yeah. So I have the hope and I actually am hopeful. So basically, like there's there's like. Well, just to underscore what we got to, because you're answering the question I just asked, but I just want to underscore that. It seems like some kind of terrible pain recession is inevitable on that rate reset, given the interest rates, even in a soft landing. It seems like it's almost catastrophic and unsustainable what will happen as those higher rates start to move in, 25, 26. Seems like a recession would be inevitable, and maybe that's the best case scenario you have. you also face the risk of maybe something breaking, which is we stopped talking about that because those interest rate payments, servicing that debt gets so difficult.

18:18So that's the dilemma we're facing. And then this is what we're, how is it possible? Is that fair? Right. So basically you have$2 trillion a year more you have to pay. So how can we possibly, where's the money come from, right? How can we possibly do that? and there's basically three levers we have, right? Which is high real growth, high nominal growth and or slowing the amount of debt we have. I guess there's another one, which is you can print your way out. You can borrow your way out of it, but that doesn't, that's just - You can print money. That delays it. There's a worse version where it gets worse, but I'm saying that this is where it gets better.

18:57So how could you actually, how could we basically sort of dodge this bullet? And high real growth, what's interesting about high real growth is that it basically happened before. And that low real growth was like what we've been experiencing since 2000, mid 2000s, basically great financial crisis to the pandemic was a low growth period. And I think, and I think it's a pretty clear likelihood that we go into a high growth period because of AI. And so we get that extra growth, we basically can grow our way out of the hole, the$2 trillion hole. So that's one possibility. And another one, which is similar, is just high nominal growth.

19:42And what I don't know if most people know, but during the 2010s, we had really poor growth. I mean, it was because of the low productivity growth. But low growth just absolutely kills not just the economy, but it also has all these political and social consequences. And so it's actually, all you have to believe is we go back to a period of high growth that was normal in America before the great financial crisis. And we're seeing it in the economy today. So both these things seem not just feasible, they actually seem like they're happening at the moment. So it's very promising. And the third thing when you happen to slow the debt growth, and this is, again, counter to the narrative everybody thinks, which is that we have a lot of debt growth, but debt growth slowed.

20:33Deck growth slowed a lot. And so if we can maintain basically the slower debt growth and have higher real and nominal growth, basically, that's the magic. And just to sort of like, you know, if you want to know what's your, like, I give my kids an allowance every day, like what's the allowance, basically, we can actually have an allowance of$5 trillion a year of new debt. And the federal government can just borrow$2 trillion a year. And everybody can basically, businesses, banks can continue to grow the way they have. And the household, the interesting thing is that the reason why debt growth slowed so much in the last decade was because household debt growth slowed down.

21:16Everybody else actually maintained high debt growth, but household debt growth slowed from what it used to be 6, 7, 8 % to 2.5%. And I think one of the reasons why household felt so strapped, like why households, people, it felt poor, but businesses and banks and governments felt rich, is that they were borrowing a lot more money at much faster rates than individuals. So why do you think that is? Why is household debt, the dynamics so different? Because it doesn't feel like we do anything that, in fact, most people would say they feel like their university costs. higher, healthcare costs are higher.

21:56Do we know why that seems like an anomaly? Do we know why that is? I have some of the answer. First is after the great financial crisis, the housing crisis that caused debt loads to come down across everything. And then mortgage standards, mortgage underwriting standards, the credit requirements of borrowers for homes really tightened up. And so most of the borrowing of households is home mortgages. And home mortgages became a lot harder to get at a much lower LTVs or at much lower, you can't get a 96 % loan very easily anymore. Yeah. It's an 80%. So that's the biggest driver is the home, So basically, that's why home prices haven't fallen that much in this cycle is because the households were so lowly levered.

22:56They have low fixed, they have super low interest rates. And so the households are really healthy. And that would be, so you'd have to see a deterioration of home lending standards, I think, to see households start to have ballooning borrowings again. That's so, I mean, it's really interesting. I really don't think anybody is thinking about debt in that way, because all you hear is we have never been spending more post-COVID, you know, that whole scenario. Yeah, here's the math. It's not true. So here's the, here, I'll just give you the final slide, which basically like, how do we pull this off, right?

23:38We have to have basically a Goldilocks. We have to have fast growth of the economy, GDP. And that could be because of technology. That could be for lots of good reasons. You slow the debt growth, which actually seems very realistic. And then you have to have moderate interest rates. You have to have Fed funds, the soft landing, because there's no way you can close a$1 or$2 trillion gap, but you can't close a$3 plus trillion gap. Yeah. So so I guess my one of my takeaways from this is that the that the if we can't lower rates because of inflation or because of, you know, demand for debt, whatever the drivers might be, then then then then a wall is inevitable.

24:26The economy will have to hit a wall because, you know, the amount of time it would take you to grow your way out of that hole is probably too long before you can no longer afford it. So this is very, very interesting and important because I guess, do you think, so we started this saying that the thinking, the general thinking was that we were going to see three rate cuts. The markets pared back that six rate cut expectation. But now there's murmuring in question. Does that really happen? Can they really do it? The inflation data seems like it's sticky and headed in the wrong direction. Do you think the Fed cuts rates anyway at some point because they have to because of the debt?

25:09And they prioritize that over inflation, even though their mandate is inflation and full employment, that they find the cover somehow. And they're going to be forced into a corner to reduce rates because of the debt situation. Yeah. Yeah. I mean, if you don't mind, I'll go back to the sort of the punchline slide. Yeah. Which is, I feel like people are so focused on the short term, but there's, even when they cut rates, which you see here in this, right? And this is the Fed.map forecast, right? All I'm taking is the Fed.map, which they updated a little bit a couple weeks ago. But there's still a lot of tightening happening as a consequence to higher rates as these things.

25:52And so this slowdown, the fact that it hasn't slowed down yet doesn't mean that it still has a lot of tightening left on the economy. Another, you know, talking about half a trillion dollars of additional debt service payments that are going to eat into consumption. And so the market is just, the problem with the market is it has such a short attention span. It really has like a memory that lasts three to 12 months at most, maybe even like three to 12 weeks. And so it's because the rates went up. Basically, the things that are different this time is rates went up really fast. And second is that we had been in a period of a decade of ZERP, almost 15 years.

26:39And so more people were fixed at lower rates. If you go back to 2008, that period, there had only been a period of low rates for three to four years. That's super important, Ben. That's a super, super important point. That window of locking those low rates in, there were just less people. But now, especially when you're in the U.S., a little bit different everywhere else, they have more floating mortgages. But here, for a decade and a half, homebuyers basically were able to lock into very low rates. So that's going to hold things steady for way longer. So it sounds like you're saying the Fed is trying to do something which I don't know that they've done before, which is game out the fade.

27:24You know, like sort of they don't really know or maybe they have some idea. You just gave us a good plot of when these rate resets happen. And so they're trying to hit that sweet spot where they're going to start easing so that that lag from the easing happens in time to be able to prevent the still coming pain from those rate hikes. So they may start hiking when it still looks strong because they know that the weakness is coming, but they're front running it. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

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28:47And unlike money, gold can't be printed. It's your shield in times of economic uncertainty. Invest in something you can hold. Go to noblegoldinvestments.com slash vision to get started. Don't wait. That's noblegoldinvestments.com slash vision. That's the only way you can get ahead of it. The whole argument that you can drop rates all of a sudden and prevent a recession. I mean, in 2008, that didn't work. In 2001, that didn't work. And I mean, it's not actually how the economy works. There's a leading and lagging effect from interest rates. And the lag effect is, I mean, look, you're seeing it here.

29:32I mean, it looks like it's, they will have started raising rates in 2022. And the cost of that hits in 2026, four years later. Yeah. Do you think that, I mean, this is fantastic stuff. And I'm so happy that you shared it with us. And I think it was worth doing things a little differently for this, because this is the issue that we're all chewing over. Just want to get your thoughts quickly on the AI side of it. Because as I mentioned at the start, you have this very unique perspective where you are so, and your background is so locked into the great universe because of your commercial real estate background.