Higher Interest Rates... and the Coming 'Zombie Apocalypse'

The Weekend Edition is pulled from the daily Stansberry Digest.

 Cash hasn't returned anything more than pocket change in a long time...

It has been more than 15 years, in fact.

In 2007, you could have put money into a savings account, a certificate of deposit ("CD"), or a bond or bond fund and earned about 5%. Since then – only until very recently – returns have been less than 1%.

Today, if you put $100 into an average one-year CD – which is a fixed-term bank deposit at a preset interest rate – at the end of that year, you'd get back around $101.20... for a 1.2% return. If you were ready to lock your cash up for five years, and you're willing to shop around for the best rate, you could earn a whopping 2.25% per year.

Buying a bond will get you a higher yield... and more risk, of course. The iShares Core U.S. Aggregate Bond Fund (AGG), a big corporate bond fund, has a yield of 2.9%... but shareholders have lost around 11% over the past year.

The last time the average interest rate on a one-year CD topped 1% was back in May 2009.

That is changing, though...

You see, the Federal Reserve has been hiking interest rates this year. As a result, CD rates are sitting at a little more than 1% today. And many economists think that by 2023, the Fed will have raised rates to as high as 2.75%.

It's no question that inflation is a top concern of everyone right now. The annual inflation rate recently clocked in at 8.5% – the highest in more than four decades.

Continuing to raise interest rates is one way the Fed can strengthen the buying power of the dollar – which, in turn, offsets inflation.

On a closer look, though, the effects are more complicated...

Just to state the obvious, higher interest rates mean that it will cost more to borrow...

As a result, companies and people will borrow and spend less. All things being equal (which they rarely are, outside of economics textbooks), that will reduce inflation.

It also means that mortgage rates are moving up...

Thirty-year mortgage rates are now sitting at a national average of 5.58%. When it costs more to buy real estate – that is, when the cost to borrow money is higher – fewer people will buy, and demand will decline. The Fed hopes that falling demand will bring down home prices over the long term.

Furthermore, as interest rates rise, share prices can tumble...

This is because investors can earn higher rates of return on their money in bonds and income investments, by taking some cash out of higher-risk assets (like stocks) and putting it into safer assets.

That's not to say that tens of billions of dollars of speculative money in Robinhood Markets (HOOD) accounts will suddenly flow from meme stocks like GameStop (GME) and AMC Entertainment (AMC) into 1% CDs... Not likely.

But there will always be some nervous cash ready to walk away from stocks in favor of something safer.

And the higher rates go, the more people will fear a market crash on the horizon... and the more they'll move money to a safer haven.

This could also put the federal budget in danger – in more ways than one...

In 2020, the U.S. government's federal budget amounted to $6.6 trillion, according to the Congressional Budget Office. Of that, $4.6 trillion was for what's called "mandatory spending" – including Social Security, Medicare, and Medicaid.

Another $1.6 trillion was set aside for "discretionary" spending. Discretionary spending covers defense and everything else – from health to justice to agriculture to education.

Well, that is... "everything else" except for $350 billion in interest payments on federal debt.

The government's debt load currently stands at just $30.4 trillion. And in comparison, those interest payments might sound more like a rounding error... just 5.4% of total spending.

But that $350 billion, according to the nonpartisan think tank Committee for a Responsible Federal Budget ("CRFB"), is more than four times what the government will spend on housing... more than four times what Uncle Sam spends on K-12 education... and eight times what it will spend on science, space, and technology.

In other words, $350 billion in interest payments might not buy what it used to, but it's still an important amount of money.

As rates continue to rise, those interest expenses will rise as well...

For instance, a one-percentage-point rise in interest rates would boost the amount of money paid on interest on the federal government debt to $530 billion...

That's more than the cost of Medicaid, according to the CRFB. And a two-percentage-point increase – entirely possible by 2023 under current projections – would raise it to $750 billion... That's about as much as all government spending on defense.

With a three-percentage-point increase, the government would be spending nearly $1 trillion on debt interest alone... which is around 20% of total federal tax revenue and approximately as much as is spent on Social Security benefits every year.

Can the U.S. government afford to pay more in interest?

Put it all together, and it sure doesn't look like it – short of a cataclysmic tax hike that would be political suicide.

The Fed could, in theory, print as many dollars as the government needs to make its interest payments. But Uncle Sam having to bail itself out like that will likely lead to... you guessed it... even worse inflation.

Another alternative is to cut spending... But there's not a lot of wiggle room there.

In short, the federal government is staring down the barrel of a true debt crisis. It could threaten the stability of the U.S. dollar... and throw into further doubt the status of the dollar as the world's reserve currency.

As I wrote in an October 2020 Digest, the U.S. dollar has already worn out its welcome as the global reserve currency. Higher interest rates could be what finally tips it over the edge.

Previous debt-ceiling negotiations haven't addressed the issue, either... And Congress has delayed the next debt-ceiling standoff until after midterm elections this November. (Any real discussion of the cost of debt is delayed until... forever.)

All this begs the question: Will we really see all the rate hikes that the Fed has planned? If the federal budget just can't handle higher interest rates... well, something has to give.

But believe it or not, some companies may be in even bigger trouble than Uncle Sam...

As my colleague Mike DiBiase, the editor of Stansberry's Credit Opportunities, explained in a July 2021 Digest...

U.S. companies have simply gorged on debt since the last financial crisis. Corporate debt is up 70% since the end of 2008... It now tops $11 trillion.

This is just an acceleration of a trend that goes back four decades. Corporate debt has increased nearly 1,200% over this period.

And companies have been able to do that because, of course, interest rates have been so darn low for so long. When it costs so little to borrow... well, why not borrow more? Borrowed money can fund growth.

But a lot of this debt won't be repaid, Mike says. The credit quality of corporate debt is at historically low levels. Around a quarter of all companies in the Russell 3000 Index were "zombie companies" at the end of last year – which means that they don't earn enough profits to cover interest payments, to say nothing of the full borrowed amount.

As Mike explains, these zombies are now facing higher interest payments. And that spells trouble...

The cost of the debt will be too much for many borrowers to handle. Higher rates will set off a wave of bankruptcies like we've never seen before.

So what's the solution?

The Fed could stop hiking interest rates... The White House could try to raise taxes... Or inflation could continue to rise.

In other words, it's like choosing between fried liver, boiled Brussels sprouts, and a day-old mayonnaise sandwich: There are no good options.

No good options if you're a policymaker, that is. Investors have many options...

If stocks go up, if stocks go down... if rates go up, if rates go down... there's always a smart, low-risk place to put your money.

And with recession fears mounting, now is the perfect time to take control of your finances and seek safer opportunities outside of traditional markets.

Good investing,

Kim Iskyan

Editor's note: Raging inflation and a looming recession have sent investors scrambling for ways to make stock-like gains with lower risk... outside of the traditional market. And Mike's Stansberry's Credit Opportunities service focuses on doing just that. What's more, a once-in-a-generation opportunity just cropped up that could make you 700%-plus with his investing strategy. Click here for more details.