The U.S. Federal Reserve last week poured cold water on the widely held hope that it would soon make money cheaper by lowering interest rates. At Kevin Warsh’s first meeting as chairman, on June 17, the Fed left its benchmark rate unchanged, but signaled that rates will likely be higher at the end of this year than they are now—a sharp reversal from what its own officials had forecast back in March.
Markets reacted at once. The interest rate the U.S. government pays to borrow for two years—a closely watched barometer of where rates are headed—jumped to 4.21%, its highest in more than a year, as traders bet a rate increase could come as soon as September. Stocks fell across the board.
But the real danger is not on Wall Street; it is on main streets in the developing world. Poorer nations borrow heavily in dollars, and most must constantly take out new loans to pay off old ones—"rolling over” their debt. When the Fed keeps rates high and the dollar strong, every one of those dollars gets more expensive to repay. That squeeze is arriving at the worst moment: developing-country government debt has hit a record of nearly $12.1 trillion.
What the Fed is not addressing is the speculative financial system itself. The Financial Stability Board, which monitors global financial risks, has warned of mounting trouble in “private credit”—a fast-growing, relatively unregulated type of lending run by investment funds rather than banks. Private credit defaults are nearing 6%, and a growing share of borrowers can no longer pay their interest in cash, going further and further into debt. At the same time, the Bank for International Settlements warns of the more than $500 billion that banks have lent to software companies whose business the AI boom may itself be making obsolete. In short, the productive economy—farms, factories, infrastructure—is being starved of affordable credit, while the money pours into financial paper: bets on bets, rather than things that are built.