There’s a little-known truth to interest rates that is likely to surprise you.
Even though inflation remains elevated, the Federal Reserve is likely to cut rates. Why? The U.S. government needs it to.
At the heart of this truth is the difference between nominal and real interest rates. Nominal rates do not take inflation to account. Real interest rates do.
If inflation is higher than interest rates, the cost of capital is not compensating for the rising cost of goods and services. When this happens, it means that inflation is rising more than interest expense, which helps ease the burden of that interest expense on borrowers, and more specifically, governments.
The history of interest rates tells a consistent story throughout time. Most of the time, interest rates are LOWER than inflation. Politicians want rates to be lower than inflation because the surest way to get elected or reelected is by promising more to your voter base. When rates are lower, inflation helps pay for “freebies” for voters.
The Real Secret of Interest Rates
Put another way, the government – with over $34 trillion in outstanding debt – needs negative real rates.
When real interest rates are lower than inflation, the real value of the government’s outstanding debt shrinks. Over time, this essentially decreases the debt burden while the nominal value of the debt remains constant but purchasing power erodes due to inflation.
Right now, we have real interest rates that are relatively high, which makes sense given that the Fed wants to clamp extreme inflation down. But the Fed realistically can’t keep real rates higher for longer with federal debt climbing to new levels.
With over $34 trillion in government debt outstanding, not including unfunded liabilities, there is no choice but to have real rates turn negative.
This means that the truth about interest rates is that there is an incentive to keep inflation high… at least while government debt is ballooning. This same truth is why the Fed will move forward with rate cuts even if its fight against inflation isn’t over.
What does this truth mean for you? Gold prices typically shine in times when real interest rates are lower. If you anticipate that the Fed will soon act to lower rates, you should get ahead of the curve and buy up the precious metal now.
On the date of publication, Michael Gayed did not hold (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
