Chart of the Days: Real Negative Rates are Here

Many have suggested that we would never see interest rates go negative. In fact, they are negative today and have been so in the recent past. Our central banks have not so cleverly been hiding it from the population.

The real interest rate is calculated as the difference between the nominal interest rate and the inflation rate. The chart above displays the nominal interest rate of a 1-year US Treasury bond, the US inflation rate, and the resulting one-year real interest rate.

Inflation is defined as the yearly percentage change of the Consumer Price Index (CPI). When inflation is high, prices for goods and services rise, and thus the purchasing power per unit of currency decreases. The chart below shows that adjusted for inflation, the yields on US Treasuries (blue line) have often been negative over the long term.

Currently, the nominal interest rate is 0.43%, the US inflation rate is 6.81%, and the resulting one-year real interest rate is -6.35%. See here the source data.

As you can see from the chart, real interest rates are lower today than they were during the depths of stagflation in the 1970s. One would need to go back to WWII to get to the levels of real interest rates that we see today.

In order to truly tame inflation, the Federal Reserve would need to push interest rates above the level of inflation. Nobody is talking about rate hikes up to 7%. And remember, the government uses a cooked CPI formula that understates inflation. When measured honestly, inflation is closer to 10-15%. There is no rule that says that they can’t go even further negative – they have in the past.

Paul Volker had to take rates to 20% to finally tame the inflation of the 1970s. That’s certainly not in the cards – yet. It would crush a US economy built on easy money and debt. One way or another, this chart will need to be addressed, and economic pain will one day occur.

What could go wrong?

See more #chartoftheday posts.

 RWR original article syndication source.