Rising tide of interest rates puts the world in deeper water
Suburban America, Latin America, and Capitol Hill are bracing for a frontal system of higher interest rates. Mortgages, foreign debt, and government borrowing will all get more costly. Many economists expect interest rates to continue rising into 1989 as the Federal Reserve struggles to cool inflation and slow down the United States economy. Irving Trust in New York, for instance, sees the prime rate, which is now 10 percent, at 10 percent by the end of this year and 12 by the end of 1989.
``The underlying fact is that inflation is picking up,'' says Michael Andrews, Irving's international economist. Interest rates must rise to keep in step, he notes.
Inflation also provides a handy rule of thumb in trying to determine who can weather rising interest rates, says Lacy Hunt, chief economist of CM&M Group in New York. If wages and prices climb faster than interest rates, then servicing higher debt is not necessarily painful. But the other way around hurts.
Take Latin debtors, for example. Until recently, commodity prices had been increasing faster than interest rates. That was reducing debt-export ratios (how much hard-earned money goes into loan payments). But in recent weeks, the price of a key commodity, oil, has been weakening. This is cause for concern in Mexico and Venezuela in particular, because the cost of servicing foreign loans is rising faster than income from oil exports.
Most Latin loans are linked to the London interbank offered rate (LIBOR), which has risen roughly two percentage points over the past six months. If forecasts of even higher interest rates are correct, recession and the need for highly unpopular austerity measures in Latin America will almost certainly intensify.
International bankers offered adjustable-rate loans to Latin nations in the 1970s, says economist William Cline of the Institute for International Economics in Washington, so as to hedge against sharp fluctuations in inflation. Now, Dr. Cline notes, debtors find variable-rate loans quite distasteful. Given the choice today, he says, ``most would prefer to borrow with bonds.''
Higher interest rates also mean tighter money for American families with adjustable-rate mortgages.
Like third-world governments, several million Americans have debts that increase as underlying interest rates rise. The Mortgage Bankers Association in Washington estimates that there are some 4 million adjustable home mortgages among the 40 million mortgage loans outstanding in the US. There are also 1.3 million Americans with in home-equity loans, amounting to $50 billion, almost all of which are pegged to moving interest rates such as the prime.
Although these people will be paying more to their lenders, economist Richard Peach of the Mortgage Bankers Association says this will not contribute significantly to delinquency or default rates. One reason interest rates are rising, Dr. Peach points out, is that the economy has been growing so strongly. That means lower unemployment and higher wages. These tend to counteract somewhat the higher mortgage payments.
What's more, Dr. Hunt of CM&M adds, American consumers should get a big increase in interest income from money-market accounts and other interest-bearing investments. In the first quarter of this year, for instance, personal interest income for Americans was $566.7 billion, while interest expenses were $100 billion. As interest rates rise, these savers benefit.
Mortgages and most home-equity payments, moreover, remain tax deductible, so borrowers recoup much of their higher debt payments. But because of new tax laws, Americans can deduct only 40 percent of their credit card and auto-loan debt this year. The percentage falls to 20 next year and to 10 percent in 1990. Credit card interest rates are in the 18 to 21 percent range already. Most credit card rates are adjusted automatically with the prime. A small number of car loans are also adjustable.
Finally, although the effect is not as immediate as with adjustable-rate loans, higher interest rates hamper Washington in its efforts to bring the federal budget into balance.
The government must offer higher rates to attract buyers for its Treasury notes. Over the long run, that means more money for straight debt service - an expense that worsens the budget deficit without producing government programs in return. Since 1980, this interest expense has tripled, from $52 billion to $148 billion.
``It is pure dead-weight loss,'' notes Barry Bosworth, a specialist on fiscal and monetary policy with the Brookings Institution in Washington. ``It is an involuntary payment to meet government obligations, with no net change. It's hard enough getting Americans to pay higher taxes, but try to get a tax increase to meet interest payments.''