What's Going On?
Marvin Gaye was asking the right question
In 1971, the Vietnam War was raging and American students were raging against it. Across the globe, a cultural revolution was also in motion; the changes affected music, clothing, art, politics and society. It was a moment in time whose impact would define a generation, and be felt by the generations that followed.
There are periods in history when the ground shifts beneath us, transforming the current landscape and the opportunities it provides. Our long-held assumptions no longer apply. What used to seem “doable” is now impossible, while the impossible is suddenly within reach. You find yourself wondering, as Marvin Gaye did in his 1971 hit song by the same name, “What’s Going On?”
I believe we are in one of those transition periods. The change is less violent, but equally confrontational, crossing a divide that is just as wide. This time, though, it is a change driven partially by dissatisfied workers and households, a populist frustration with the perceived status quo. The behaviors of the past are no longer present, or at least they’re not showing up in patterns we recognize. Trends we assumed would continue do not, and “if-then” statements fail to hold. Today is a moment of retrenchment for established business operators, a moment of reconsideration for entrepreneurs, and a shifting moment of risk for investors. I think of it as The Great Reset, and its effects will be felt across the economy.
Beneath that visible change, the U.S. economy is pivoting in two fundamental ways, and I believe these changes could reverberate for years to come, resetting people’s expectations for growth and stability. The pivots sound mundane, but under the surface they’re central to the way we behave and make decisions. So what, exactly, is going on? Interest rates bottomed and labor costs did too.
Interest Rates
Short term interest rates—defined as the Federal Reserve’s overnight borrowing rate—peaked in the summer of 1981 at 22% (that’s not a typo), as the indefatigable chairman, Paul Volcker, clamped down on runaway inflation in the wake of the Middle East oil crisis. That peak and reversal introduced a 40 year trend of declining interest rates, which ended in 2022, when the Fed, after a tumultuous Covid crisis and much debate, raised the Fed Funds Rate from zero to not zero. We quite literally took rates as high as they have ever been, and then as low as we could.
There are, of course, direct consequences related to the simple math of that cycle: the borrowing cost for every company was roughly in decline for two generations, along with mortgage costs for every home buyer, and project finance costs for every business. This has meant that households could expect to refinance at a lower rate, corporations could maintain long-term assumptions about borrowing costs, and the U.S. government would provide seemingly infinite liquidity. Fifty years ago, a first-time home buyer paid mortgage interest as high as 17%, and then, as rates fell over the next three decades, was able to continuously refinance that loan, sometimes trading up to a bigger home, or extracting cash from it for vacations and college tuition. We ran into a bit of trouble in 2008, when that trend led to overexuberance, but regardless, declining financing rates have been a core part of the economy.
Then, for roughly thirteen years after that 2008 crisis, rates remained (with a bit of volatility) near zero, as the Federal Reserve held the overnight funds rate at the so-called lower bound. There was some fluctuation in between, but finally, in 2022, rates came off the bottom.
That reversal is highly relevant. In 2025, home buyers are now looking at rates that are twice what their neighbors paid four years ago. Frustrated young families are now priced out of the market, and established homeowners cannot afford to buy the house across the street. Business operators can no longer assume debt will cost the same or less. The Fed is no longer providing excess liquidity. In sum: debt is no longer something taken for granted, which means debt-financed growth and debt-financed consumption are no longer the baseline for businesses and consumers.
If those changes in behavior around the cost of debt—the interest rate—are obvious, there’s also a second, more subtle, and more significant issue related to shifting interest rate regimes. Our expectation of lower rates, together with the Fed’s historical commitment to fighting inflation, led us to experience and trust in economic stability. It may be hard to believe, but since 1983, as interest rates marched lower, and inflation became subdued, our economy has only experienced four recessions, one of which was the unique and very brief Covid recession. That has not always been the case: in a rising interest rate regime, like the period of time between 1948 to 1982, the U.S. economy experienced eight recessions in a shorter thirty-four years.
Many readers will rightfully accuse me of oversimplifying the issue here, but there is no doubt that assumptions of lower interest rates and stable prices result in more stable decision making. That stability has, for decades now, led to higher risk tolerance and capital availability. Conversely, assumptions of higher and more volatile interest rates will likely prompt business owners to be more conservative in their planning, and will give investors a smaller appetite for risk.
Labor in an age of geopolitical instability
The second and equally important shift is in the labor market. Over the last 30 years, imported goods produced in low cost labor markets have shifted production abroad and transformed the U.S. economy into one led by the services sector. The net result is cheaper goods and a shift in focus: mid-skill manufacturing jobs have been replaced by lower skill service jobs. The trend largely began in 1994, when the North American Free Trade Agreement made the globalization of manufacturing the standard, rather than an anomaly. For the next three decades, U.S. companies dutifully followed the Ricardian theory of comparative advantage, outsourcing production, first to Mexico and Canada during NAFTA, then to the broader emerging market economies like China, and, more recently, to India. While this trend has made consumers happy, it created a very damaging wage dynamic for U.S. wage earners.
As the economy responded to globalization and evolved away from manufacturing and toward services, there was also a domestic shift: we separated domestic labor from direct company employment, which accelerated the downward push in real (inflation adjusted) wages. In his important and insightful book, The Fissured Workplace, David Weil, former head of the Division of Wage and Hour at the U.S. Department of Labor, describes the dissociation of workers from employers, not only through global supply chains, but also through subcontracting and franchising. Essentially, large service companies have outsourced responsibility for services labor to third party companies, reframing labor as a fungible commodity. Hard working wage earners paid for that shift with more modest incomes. Twenty five years ago, the inflation adjusted weekly earnings for wage and salary workers was $335 (based on 1984 prices). Over the next eighteen years that median wage rose slowly to just $350 in 2018—only a 5% gain in nearly two decades.
The tightening of the labor market since 2018 has effectively reversed that trend. The median wage is now more than $370, a rise of nearly 6% in real wages in over just seven years. This is good news for workers: the dynamics of a tight labor market have shifted and, I believe, become durable. It is also worth noting that this recent acceleration in wage growth occurred before the changes in immigration policy, which will constrain the supply of workers, most likely causing upward pressure on wages.
While that wage pressure is good for households, it will have a negative consequence for investors and business owners: the supply of cheap labor to support domestic corporate profits will no longer be a given.
The combination of these two trend reversals will affect the U.S. economy for some time: going from an “always lower” interest rate regime to a “probably higher” interest rate regime, along with the pivot from stagnant real wages to rising real wages, has important implications. The psychology of decision-making will shift from a framework of risk-taking to one of conservation, and will be felt across many sectors. Risk taking by both entrepreneurs and the investors who back them will likely be less aggressive. Corporate planning cycles will probably shorten as concerns about the economy become entrenched. As labor costs continue to rise, expectations for corporate profits will have to adjust, particularly in the services sector, which comprises more than ⅔ of the US economy. For households, rising labor costs, or wages, are no doubt a positive development, but that is partially offset by higher mortgage costs and higher prices everywhere.
The net result is neither doom and gloom, nor an imminent recession. But it is an important downward shift in long run growth rates, and an upward shift in our assessment of future risk. It’s a change in perspective that may well be an uncomfortable but lasting transition. The great reset for investors is here.
