What Recession? Low Interest Rates Could Mean Tech-Fueled Growth

The financial world is buzzing with an arcane sounding issue—the inverted yield curve. Here’s what that means: The overwhelming majority of the time, the longer you want to borrow money for, the higher the interest rate. So a 30-year mortgage will typically carry a higher rate than a 15-year mortgage; that’s true of government bonds as well. Every now and then, however, that script flips, and rates for short-term debt exceed those for long-term debt, “inverting” the typical yield curve. That’s the situation now. Lend money to the US government for one month, and Uncle Sam will pay you 2.01 percent interest; lend it for 10 years, and you’ll only get 1.47 percent (per year). Here’s why that matters: An inverted yield curve historically has been a reliable indicator that a recession is on the horizon.

Every recession since 1950 has been preceded by an inverted yield curve, though the curve also inverted in 1965 and 1998 without a recession following in the next 18 to 24 months. The reason why an inverted yield curve is a reliable predictor is straightforward: If investors believe that future growth will be so lackluster that they don’t need to demand a large premium for lending money that won’t be paid back for decades, that should signal trouble. The past predictability of the inverted yield curve has led to today’s widespread assumption that the US economy is slowing and will soon dip into recession; market watchers have thus begun to view economic data with an eye toward seeing problems ahead.

But past is not always prologue. It might be foolish to dismiss the inverted curve as a potential warning sign, but it would be equally unwise not to ask whether this time is, in fact, different, and whether technology is playing a decisive and underappreciated role.

To start, it’s important to recognize that rates have stayed lower over the past decade than supposedly prescient market watchers had thought. When the Federal Reserve and other central banks cut interest to zero during the financial crisis of 2008–09, the assumption was that these emergency measures would eventually give way to more “normal” rates. In a 2013 speech, then Fed Chair Ben Bernanke noted that the Fed’s models and the Congressional Budget Office were predicting rates on the US 10-year Treasury of close to 5 percent by 2017. That didn’t happen; the rate is below 1.5 percent.

For some, the reason rates remain startlingly low is because central banks, and the Fed especially, have kept them too low. The claim is that rates have been “artificially” depressed by central banks, “distorting” the economy. The flip side to that argument is the relentless pressure on the Fed by President Trump, who believes that the Fed is keeping rates too high. He wants the bank to cut rates even more aggressively to juice economic growth.

But what if the role of central banks is overstated? US interest rates were creeping up until early this year, as the Fed gradually raised its short-term targets. Then, even before the Fed reversed course, interest rates began to plunge over the summer, in parallel with rates in other developed economies such as Germany and Japan. Clearly, some big market participants were anticipating slower growth, especially in the face of the US-China trade war.

But what if rates are falling because technology is systematically depressing prices? If a wide swath of goods and services is getting cheaper and cheaper, then people and businesses and government don’t have to spend as much for the same things. Yes, fighter jets and prescription drugs are more expensive than ever, but that’s more because of government and market distortions than because the products are more expensive to make. In many sectors of our economy, things are becoming less expensive, not more. The result: less inflation, and slower nominal economic growth (some of which is attributable to inflation), but not actual contraction of economic activity. If you buy 100 of X at $100 a pop one year, and then you buy 100 of the new version of X two years later at $90, you’ve gotten what you need for less. That’s good for you, but the country’s GDP will decrease because you spent less.

The role of deflation and technology has not been ignored, but it has hardly been front and center. A recent analysis by Ark Investments suggested that in times of profound technological innovation, such as the late 19th and early 20th century, deflation can be common. This can confuse investors and lead to wild gyrations of long- and short-term interest rates.

The Industrial Revolution unleashed mechanization, leading to a proliferation of goods at cheap prices. Today, waves of software and communications technology are having a similar effect. Add to that the early stages of artificial intelligence and robotics, which allow more output at less cost (including the challenging issue of less labor). The AI revolution is significant, but our productivity statistics, grounded in 20th-century notions of manufacturing workers making things, have a hard time capturing these changes. Then consider that increasing portions of economic activity are digital and often free to users (think Google or Facebook), further confounding our ability to gauge what’s happening and what’s likely to happen in the future.

These technologies are unleashing more affordable goods and services around the globe, but deflation poses threats to financial markets; almost all investment is predicated on the assumption that a dollar invested today will yield more tomorrow. The venture capitalists of Sand Hill Road look for 10, 20, and even 100 times the return on their initial investment. Indeed, this is where the conventional wisdom around inverted yield curves seems most potent: If investors underperform and savers can’t get anything for their savings, that can create turmoil in the global financial system.

The larger point, however, should not be lost: An inverted curve auguring a deflationary world is not necessarily predicting a recession, as in the 20th century, nor does it augur the kind of pain experienced in 2008–09. There may yet be a substantial economic crisis, but the flattening of interest rates globally need not be a harbinger. Quite the opposite; a world where capital is cheaper, connectivity greater, and goods inherently digital could be one of widespread affluence, defined not by levels of GDP growth or income but by more access to goods and services by more people. That could mean statistically low to nonexistent GDP growth, very low interest rates, and close to zero inflation. It will not look like economies of the past or behave like them.

None of this is to discount the short-term confusion of financial markets, nor the likelihood that the US and world economies may be slowing in the face of questionable trade tariffs and incoherent policies in Washington and elsewhere. But the assumption that past patterns hold the same sway in a world that is morphing technologically and economically must be continually challenged. As much as economists and market watchers may want, nothing stays the same forever. An inverted yield curve may tell us something, but it may not tell us what we think.