Do you remember the economy of the late 1990s? Or, if you're too young to remember (and I hope at least some of my readers do), what did you hear about the economy back then?
It's probably remembered as a time of prosperity with low unemployment, a booming economy and low inflation that was marred by an irrational stock market exuberance. Have you heard of Pets.com?
You probably haven't noticed, but the economy in early 2024 looks a lot like the economy at the end of the Clinton administration. People may not feel prosperous, or at least they would say they don't, because there is a big gap between Americans' positive assessments of their personal financial situation and their negative assessments of the economy. But looking at the numbers, things look pretty good. Notably, the unemployment rate is a bit lower than it was in the booming late 90s.
What about inflation? Inflation was seriously elevated in 2021 and 2022, but has since come down substantially. Sure, the past few inflation reports have been disappointing, but in large part that probably reflects statistical noise. The New York Federal Reserve has a measure of underlying inflation that tries to filter out the noise. I like this measure because it's an algorithm with no human input, and therefore leaves no room for motivated reasoning. The measure shows that underlying inflation is still slightly above the Fed's 2% target, but not by much.
But what about interest rates? In particular, many would-be home buyers are frustrated by high mortgage rates. This is very different from the situation in the late '90s, isn't it?
Surprisingly, the answer is no. People remember that stock prices were high back then, but they tend to forget that interest rates were also very high. In fact, mortgage interest rates were even higher than they are today.
And that comparison has me wondering if high interest rates will continue for much longer than many people, including myself, had expected.
Until recently, I thought high interest rates were a temporary phenomenon, driven primarily by the Fed's attempts to tame inflation with interest rate hikes. Once the Fed won that battle (and it has, to a large extent), I expected a return to the low interest rate environment that prevailed before the COVID-19 pandemic. But perhaps we are instead returning to the high interest rate environment of the late 1990s.
Why were interest rates so high around 1999? Supply and demand. The American population, especially the number of working-age residents, was still growing rapidly, necessitating massive investments in everything from housing to office buildings to shopping malls.
Business investment was booming too: the dot-com folly was still fresh in our memory, but from a macroeconomic perspective, a surge in investment in communications, including the laying of fiber-optic cables, was a more important driver of the economy.
These forces create a strong demand for investable funds, and while the Fed's decisions drive interest rates in the short term, in the long term it is the supply and demand of savings that matters.
And until recently, the conditions that kept interest rates high a generation ago seemed unlikely to resurface. The working-age population seemed likely to stagnate or even decline, given falling birth rates and aging baby boomers. Technology continued to advance, but smartphones and video games didn't seem to generate much business investment.
Then suddenly, things seemed to change.
Before the pandemic, weak demographics were the main argument for low interest rates: Birth rates remain low and are falling, while the U.S. is currently experiencing a surge in immigration that, if sustained, would dramatically change the demographic outlook.
Investment demand has also been stronger than expected. Housing investment has been performing much better than expected given high interest rates, likely due to an increase in people working from home, which has boosted demand for homes where people can work.
Some forms of business investment are also surging, but not necessarily in the way you might think: According to Chat GPT, AI “has the potential to have a significant impact on macroeconomic factors.” (I personally avoid using “impact” as a verb.) But the numbers don't show this, at least for now.
What we're seeing is a significant increase in manufacturing investment, driven in large part by the Biden Administration's climate change policies.
So we may indeed be witnessing a return to economic conditions similar to those of the late 1990s, with the good in the form of falling unemployment and (perhaps) strong productivity gains, and the not-so-good in the form of persistently high interest rates.
I didn't expect this, and to my knowledge, nobody else did, but these things happen, even though they're not written on bumper stickers.
Quick Hit
Hey, I could get through this without mentioning R-Star.
In the 90s we had dot coms, now we have cryptocurrencies. Advertising was better back then.
Are high mortgage rates trapping people in their homes?
Inflation has subsided. Crime has decreased.