Build finances that can withstand prolonged high interest rates

Kim Hak-kyun

The author is the head of the research center at Shinyoung Securities.

People generally interpret economic developments and forecast the future through their own experiences. Most middle-aged and older people have spent their working lives in an era of declining interest rates. From the early 1980s, when inflation triggered by soaring oil prices and monetary expansion began subsiding, until the Covid-19 pandemic in 2020, interest rates in Korea and other major economies declined for four decades.

The trend was particularly evident in the United States. The yield on 10-year Treasury bonds peaked at 15.8 percent in September 1981 before falling to around 0.5 percent in August 2020. Long-term government bond yields even turned negative in Japan and parts of Europe.

After such a prolonged decline, expectations that rates will eventually fall remain deeply ingrained. Even professional bond managers anticipate economic slowdowns and lower rates, yet markets have repeatedly defied their forecasts.

Rates may temporarily decline during recessions, but cyclical fluctuations differ from structural trends spanning decades. The forces that suppressed rates for 40 years are weakening while new upward pressures are emerging.

Historically, interest rates have experienced prolonged cycles driven primarily by inflation and corporate investment demand. In the early 20th century, U.S. rates rose as automobiles, aircraft and radio technology stimulated investment in factories and electricity infrastructure. World War I spending added inflationary pressure.

Rates subsequently declined during the 1920s and 1930s. Technological advances expanded industrial production, but the gold standard constrained monetary expansion. Deflation intensified when demand collapsed during the Great Depression.

The trend reversed after World War II. Keynesian policies encouraged government spending, while the United States' abandonment of gold convertibility in 1971 and two oil shocks fueled inflation. Interest rates climbed until the early 1980s.

Federal Reserve Chairman Paul Volcker then raised policy rates toward 20 percent, suppressing inflation expectations at the cost of recession. Yet central banks alone cannot explain the following four decades of low inflation and declining rates.

Three structural developments reinforced that trend.

First was globalization. Companies relocated production to lower-cost countries, particularly China, whose inexpensive manufactured goods helped restrain worldwide inflation.

Second was the retreat of government intervention. After Keynesian economics struggled with 1970s stagflation, market-oriented policies associated with Milton Friedman gained influence. Ronald Reagan and Margaret Thatcher championed tax cuts, deregulation and privatization. Fiscal discipline became increasingly important, culminating in the United States' budget surpluses under President Bill Clinton.

Third was changing corporate investment. As manufacturing shifted toward Asia, U.S. technology companies expanded through software and network effects without requiring proportionately large capital investments. Profits increasingly flowed toward dividends and share buybacks rather than factories, reducing demand for borrowed capital.

All three conditions are now reversing.

Globalization is retreating as national security increasingly outweighs production efficiency. U.S.-China tensions and pandemic-era supply disruptions have encouraged governments to reorganize supply chains and bring manufacturing home. Higher production costs are weakening globalization's disinflationary effects.

Meanwhile, big government has returned. Washington rescued companies including AIG and General Motors during the 2008 financial crisis and supported economic activity through pandemic spending. Yet fiscal deficits persisted after those emergencies ended. The United States' deficit remains around 6 percent of GDP.

Across political divisions, fiscal discipline has weakened. Heavy government bond issuance increases pressure on interest rates, while deteriorating fiscal credibility can raise borrowing costs further.

The third reversal involves corporate investment. Technology giants that previously enjoyed high profitability without enormous capital spending are competing to dominate artificial intelligence. Oracle, Meta and Microsoft are investing heavily in semiconductors, data centers and electricity supplies.

Growth once driven by software and network effects now increasingly requires expensive physical infrastructure and energy. Although the profitability of AI investments remains uncertain, their immediate financing requirements are substantial.

These changes reinforce one another. Retreating globalization raises production costs, expanding governments increase bond supply and AI investment boosts private-sector demand for capital. Higher interest rates should therefore be understood as a structural development rather than a temporary disturbance.

Households must reconsider borrowing decisions. Instead of assuming mortgage rates will return to previous lows, borrowers should assess whether they can withstand further increases. Reducing excessive debt should take priority, while property investors must calculate financing and ownership costs rather than relying on appreciation.

Financial investment strategies also require adjustment. Higher bond yields offer attractive income, but long-term bonds remain vulnerable to capital losses if rates rise further. Investors should diversify maturities and match holdings with investment horizons. Stock selection should emphasize actual cash generation over speculative growth.

During the low-rate era, cheap borrowing justified generous valuations of future earnings. Higher rates make cash flow more important and financial mistakes more costly.

Rather than continually predicting interest-rate movements, households and investors need asset and liability structures capable of surviving persistently elevated borrowing costs. The high-interest-rate era is not approaching. It has already arrived.

The central challenge is not simply forecasting the next rate cut. It is recognizing that the economic foundations of cheap money have changed and preparing finances accordingly, without depending on a return to conditions that prevailed for decades.