Interest Rates Must Go Up

Just about 5 years ago, I wrote this:

It is my theory that beneath certain levels, low interest rates do not stimulate the economy. There are several factors which combine to this result: First, when rates are very low, there is no incentive for lenders to extend credit to individuals and companies. Since the available rate of return is so low, they would rather take the sure thing on government bonds. Housing lending has continued partly because there is a real asset involved, and partly because such loans can be sold to aggregators such as Fannie Mae. [edit: this was before the housing bubble burst; the last sentence isn’t entirely true any more.]

Second, when interest rates are very low, corporate borrowers — who are supposed to be goaded into action by super low rates — are mindful that the Powers That Be feel the economy is lousy. It is a bad idea to incur debts and invest in infrastructure when the economy is lousy. What will the stockholders say? What cash they do have they will sit on until the moment is right [edit: leaving them in a position to, say, buy out a competitor who imprudently overspent]. After all, if the economy is lousy, they may well need the cash cushion. As for loans, they will wait for some kind of signal that things are improving — an increase in interest rates, maybe — before calling for cash.

Finally, the third leg of the economic table, Joe and Jane Average do not experience added liquidity. While the banks are more than happy to lend them money for concrete things like houses and cars, the banks are reluctant to lend them cash for things that have a lasting impact on the economy. They can’t get cash to start a business (or to help along their existing business) because it’s too risky — for the bank, that is.

Here we are, 5 years later. The Fed Funds Rate has been 0-0.25% for two years. That means banks are able to borrow essentially free money, and have been for two years! Mortgage rates did rise this week, after 12 weeks of declines and record lows, including the lowest rates since this data has been tracked. Under traditional economic theory, all kinds of growth should be stimulated!

So where’s the jobs that should be created by all this stimulation? Oh, right.

The truth is that monetary policy can’t fix what’s really wrong with our economy: banks and businesses we won’t admit are really failing; a workforce that can neither take advantage of job opportunities in other regions nor start small businesses because their houses have lost so much value as to leave them underwater; businesses that pay millions upon millions to executives and stockholders while paying as little as possible to laborers here, overseas, and/or illegal; tax and regulatory policies that encourage bad corporate behavior; a still-broken health insurance system that discourages hiring and will soon force all of us to pay tribute to profitable insurance companies; a failure to manufacture much of anything that somebody somewhere in the world would want.

But it gets worse. Those super low interest rates create one more problem for our economy. It punishes people who are trying to prudently save money for retirement, college, or just a rainy day. A side effect of this is that the Social Security Trust Fund is also getting low rates on their investments — which directly impacts the future of the system and gives future seniors a double-whammy even if they do everything “right.” Further, the low interest rates encourage people (and the government) to borrow money they might have a hard time paying back. While this might boost the economy in the short run, in the long run it’s just a longer bit of rope with which to hang.

Interest rates must rise. Bernanke must stop hiding the fact that some banks are already busted without effectively no-interest loans from the Fed. Institutions that are not solvent or are “too big to fail” must be broken up and turned into organizations that serve their customers. Investors must own up to the fact that their Mortgage Based Securities are worth no more than 70% of the face value and allow homes to be properly valued. Tax code must encourage corporations to spend money instead of hoarding it. And there must be incentives to hiring people here for decent wages, and better yet making something here that can be sold and exported. Let’s stop pretending we can build an economy on cheap credit and lattes.

In Closing: pants; T-shirts; it’s more intellectually honest than Megan’s Law; school reform hasn’t done much for learning; people with a prescription for painkillers might have painkillers in the house; and am I the only person with a tape measure in her bag?