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Guest Post: Seeking An Interest Rate Solution
Submitted byTaylor Cottam of EconomyPolitics
Guest Post: Seeking An Interest Rate Solution
When the Fed lowered the interest rates for overnight borrowing to near
zero, it was said to be a measure to stimulate the seized credit
markets. Low interest rates stimulate borrowing. On the demand side that
is true. On the supply side, it is clearly not the case.
The financial crisis woke America up from years of binge borrowing. Now
we had the credit hangover to deal with. So while low interest rates
were appealing for those who wished to refinance their existing debt,
there was no interest rate low enough that would tempt them to take on
new debt to finance consumption. The deleveraging process limited the
chance of success of an interest rate solution.
The country had almost overnight turned from a marginal borrower to a marginal saver.
One of the things that people forget is that low interest rates, while good for the borrower is not good for the saver.
Consumers need to deleverage their own balance sheet and the Federal
Reserve, by holding rates artificially low, not only stimulates too much
borrowing, but also stimulates too little savings. That savings will go
towards further investment. More savings, with a less steep yield curve
will force banks to start lending more. In fact, that is one of the
biggest dichotomies. A steep yield curve, while good for the stock
market, does little for the credit market.
But doesn't my bank set the interest rate?, you might ask. Is
it really true that the Fed sets short term rates? Yes it is. If you
look at the short term deposit rates as measured by the Certificate of
Deposits Index (CODI) against the Federal Funds rate, we see actually
how much control the Fed has over that rate that you and I receive on
our savings and checking deposits.
The CODI takes an average of three month term deposits and tends to very
closely mirror average rates for demand deposits and the interest rate
on short term savings.
Of course, we can't complain directly to the Fed, we can only call up
our bank. The bank will say it's the market rate, which of course is
true, but that begs the question on how we have allowed a committee of
balding PhDs to become the de facto short term rate setter? What if we
had banks themselves set the short term overnight deposit rate? The real
question that you have to ask yourself, is what should our short term
interest rates be without the intervention of the Federal Reserve.
With short term rates near zero, that brings, real interest rates, which
are the nominal rate less inflation, into negative territory. With CPI
inflation at 1.1% and short term rates near zero, that leaves real rates
near -1%. While I am not smart enough to know what the true market rate
would be, I can tell you that negative real interest rates are nothing
healthy. They have typically only existed in high inflationary times
like the late 70s early 80s. Now negative real interest rates are back.
They are not back because inflation is too high. They are back because
nominal interest rates are too low.
Negative real rates and nominal rates near zero, give an open invitation
for other countries to start using our currency as the patsy. Hence,
the carry trade is alive and well with companies and hedge funds
borrowing in the US and funding their investments overseas. Japan tried
the negative real interest rates for years to get their economy going
with little to show in terms of domestic growth.
What should rates be?
My view is that short term rates should be closer to 2%. I'm not Mr.
Market so I can't give the exact number. KC Fed chief and long-time
critic of the current policy has called for the Fed to reset the short term rates to 1%. Economist Steve Hanke of John's Hopkins suggested 2%. I think even 1% is low because that still doesn't bring the real cost of money above zero.
That brings cash onto the balance sheets of banks. That leads me to one
of the misconceptions in this crisis. Banks are not just sitting on a
ton of cash, they are also sitting on a ton of potential bad debts. They
are not cash rich, they are cash poor.
The effect of raising rates brings the real interest rate above zero and
actually incentivizes people to start saving again. More savings means
more cash on bank's balance sheets. Not until we solve the banks balance
sheets will they be willing to invest once more.
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When Ben squanders the Strategic Petro Reserve fighting the move up, and oil reaches 147 again, rates will go up.
2 months later, back to 0
God I totally agree! I don't get why Ben doesn't let the 1 year go to 1.0 - 1.5. He could pacify rightly 90% of the population. What a moron
Because he is intent on flattening the yield curve as far down, and as far out as his helicopter can take him.
@max
The multiplier is probably around -2. Every 100bp rise in rates will cost him 2% of GDP. They are trapped.
You sir, get the cigar. No point in saving when the attempt to raise rates causes the Nth dip and deflates everything back to blue-light-special prices.
the ben is buying treasury bonds so he can finance our govt(the interest on outstanding debt, defense dept, etc etc) when the fed purchases the treasuries on the open market and holds them we dont have to pay the fed the interest. WHY cuz for the fed if they dont buy the treasuries its bye bye fed reserve, congress starts printing its own debt free money(just like kennedy tried EO 11110). the bankster have no other choice. the best thing we as americans can do, is to never borrow money from a bank period, dont deposit money in a bank, take your money out of the bank. dont let the fractional reserve system kick the can down the road to your children its really that simple i think
The free market approach wouldn't guess at the "right" interest rate. But the suggestions for 1-2% rates when the money supply is exploding, the continuous commodity index is hitting record after record, and the CPI as reported is about 1.5% strike me as way too low.
The original conception of the Fed was that market forces would determine the demand for banknotes (FRNs). The concept of a "flexible" money supply was in fact the opposite of what was later made of it. When business slowed down, the Fed was expected to restrict the supply of banknotes, not increase it. Vice versa when the pace of economic activity increased.
Given there is no free market in FRNs, it is impossible to guess what the "correct" short term interest rate is. Given QE 1, 1.5 and now 2.0, my sense is that a more appropriate rate for the Federal Government to borrow at any duration is double digits. Similar to Greece. That's what you deserve when you're a Ponzi borrower. The free market is not knowingly an enabler of Ponzi finance.
Yes so simple... give people who have money in the bank interest so they can think ahead and get some real investment from that money that isn't going to deflate or inflate because of stooopid inflation measures.
Extreme short termism and scaredy cats is now getting pervasive in society and will ... not ... go away to quote an idiot... 100% confident
no, sorry I can't say that, it is too unreal... I will say a guess that this may happen or it may not.... and I think I have a good chance or maybe not that it may happen or it may not
So simple...15% BLS unemployment (25% real).
I will never, ever put more than $ 0.01 in another bank. Ever! Screw em.
Good question. What exactly is the proper interest rate for a kleptocratic ponzi scheme with nuts on top?
Having seen their credit rating? 50%
If you want banks to pay higher rates on cash deposits then make cash scarce and make them work for it. Right now too many banks are sitting on deposits that would earn just about as much stuffed in a mattress, so why lend your money to the bank for the ridiculously low rate. My bank doesn't even publish rates on checking or savings any more they are so bad, only for their worthless CD's, which earn less than some banks are paying on savings accounts.
Pay me a better rate or I'll put my money somewhere else. This idea that savers should be punished because banks are insolvent is nuts.
Beautifully stated.
Eliminate interest paid on their Fed reserves...make em 'put that money to work'.
The rate of interest is the inverse of the bond price, priced in dollars which are the 'more marketable' form of the bond & so the same thing. You can't price something in terms of itself.
Interest rates in terms of irredeemable $ are meaningless. It doesn't matter shit whether they are .2% or 2%.
And even less if those bonds end up in default.
Excellent article. All the more reason to repeal legal tender laws, the real evil in the economy. Allow each bank to set its own rates and recovery follows.
"One of the things that people forget is that low interest rates, while good for the borrower is not good for the saver. "
somebody finally gets it!!!!
jim willie does a great job of covering this issue...
the solution to the banking problem is to liquidate the abjectly mismanaged dysfunctional criminal operations run by total fucktards....a massive dose of financial ex-lax is desparately needed.
Fraud pays bigger dividends over shorter periods of time and then cause trouble. It's peoples short term viewpoints that validate fraud.
And honestly I'm not picking on the baby boomers here I'm just stating how they've been conditioned by the system. Baby boomers lived through massive inflation and it's ingrained in their psyche. They became very much pholosophically bent towards buy it now or you'll pay twice as much later. They became much more conditioned and succeptible to fraud and have probably been out there buying up stuff right and left since the crash because the crash will make people operate on their previous conditioning.
In fact buy it now or get priced out forever was a sort of psychological keyword used on them over and over by the housing industry to facilitate the bust.
They will be balanced out by the people coming in just a short while later. The pluto in virgos who are naturally much more thrifty and savings oriented. But the other big problem are the young pluto in libras who are unable to maintain any sense of identity and will become ego extensions of anything more powerful than they are or make people ego extensions of themselves if they can get away with it. They are right now drinking msm coolaide like it's the only thing you can drink and will make an excellent hitler style youth force.
"More savings means more cash on bank's balance sheets".
savings don't create money. If people were to save more, they would invest into productive assets, thereby lowering the USD price of consumer goods, and increasing capital goods. The fed are the commercial banks are the only entities that have the ability to increase the amount of cash on bank balance sheets. when the net interest margin increases then the bank is able to increase its own cash balance however I don't think that this is what the author means...
This situation is even more true for the UK where inflation has been much higher than than in the US.Yet the Bank of England has sat on its hands as inflation has risen and claimed it was temporary. There was an economist in the UK who had the courage to call for an interest-rate rise in the UK back in December 2009 and on the evidence since he was right.
http://t.co/KqKwqP3
As inflationary trends develop it is looking more and more that he was right....
If he doesn't know what they should be, why's he talking to me?
I'll tell you what they need to be: >8% on a 5yr CD
The question "what should rates be" is flawed. Rates will move regardless of what Bennie does. Rates rise during inflationary environments right? Helicopter Ben has been printing trillions since 2008 and short term Treasuries are still around zero. Ever ask yourself why? Its because deflation is winning. Volker raised rates to over 15% in the early 80's to fight inflation. Ben has lowered them to zero. Now, what does that tell you what the Fed is fighting?? They're fighting deflation.