Over the past few weeks, we have looked at the effects of falling interest rates: falling discount applied to future cash flows (and hence rising stock and bond prices), and especially falling marginal productivity of debt (MPoD). Falling MPoD means that we get less and less GDP “juice” for each new dollar of borrowing “squeeze”.

Last week, we proposed an economic law: if MPoD < 1 then the economy is unsustainable. MPoD has been falling since at least 1950, and is currently well under 0.4 (having had a temporary boost in the wake of the crisis of 2008). 0.4 means a new borrowed dollar adds 40 cents to GDP. Under irredeemable paper currency, debt cannot be extinguished. So that dollar of debt—which bought a shrinking and temporary shot of GDP—lingers forever in the system. That is the very meaning of the word irredeemable.

This is one reason why MPoD is falling. Each time that a bond is rolled, the amount is increased by the accumulated interest. This incremental debt is not productive and does not add to GDP. And also, all that debt accumulated over many decades has to be serviced, which reduces debtors’ capacity to borrow for productive purposes.

And this leads us to a discussion of the trend of falling interest. Has the cause ceased? Have we, as many say, entered a new era of rising rates? Does the Fed have the power to make it so? Is there going to be a resurgence of inflation?

We must take a moment to address the term inflation, which is generally used to mean rising prices. California just enacted a tax hike on gasoline. Right now, while it’s fresh in everyone’s minds, blame for rising gas prices is placed squarely where it belongs: Sacramento (the state capitol). But soon enough, memory will fade, and people will just think “look at how expensive gas has become.” The price of trucking will go up too, and hence the price of goods are retail. And people will blame the Fed for inflation, so called.

The word inflation is a package-deal combining two dissimilar and unrelated things together into one word. Fiscal (including regulatory) policies can drive prices up. Just look at the cost of health insurance in the US. These should not be confused with monetary effects. Milton Friedman famously said “inflation is always and everywhere a monetary phenomenon.” This is misleading, at best.

Let’s begin our analysis with an observation. If debt is rising faster than GDP, then the typical business accumulates debt faster than it grows profits. On top of that, each tick down in interest rates creates additional incentive for its competitors to invest in additional production. The result is overcapacity.

So let’s say you are a farmer in Iowa. What can you do about your debt? Grow and sell more wheat. That is, sell wheat at the bid price.

Suppose you are a restaurateur with 5 burger joints. What can you do? Cook and sell more burgers. That is, sell burgers on the bid.