Yesterday, September 17, 2015, the Federal Open Markets Committee opted to not raise rates from zero. The federal funds rate, which the rate that the FOMC controls, is the interest rate that the federal reserve charges banks to keep their money at the Federal Reserve Bank. This is different from quantitative easing where the reserve was buying bonds and flooding the economy with money.
Charging nothing to park your money does two things. First, it incentivized banks to put their money with the reserve, since it doesn’t cost anything, rather lend it out. Second, it keeps rates low throughout the economy. This was a good thing after the financial crisis. We could all get out of debt at a lower cost to borrow. But, low rates also forces people to buy assets (equity/stocks) rather than liabilities (bonds), inflating asset prices. This worked well and was the Feds main goal. However, seven years after the financial crisis, those benefits have worked their way through the economy, and the current effect is negligible. In fact, not raising rates is detrimental to the economy.
A risk free rate, for which the federal funds rate is the commonly accepted proxy, should not be zero. First, it makes the capital asset pricing model unworkable, meaning a financial calculation of an enterprise’s economic worth cannot be accurately calculated. This would be especially true for privately held companies, as there are some inferior methods to calculating fair value of a public company. Still, the pricing inaccuracy is too great. It also forces savers to become investors, as we can’t get any interest on savings accounts, cd’s, or bonds. Since we know stocks are risky and long term investments, we are less likely to spend stock earnings than we are safer interest payments, hurting demand.
Also, a slight increase in borrowing costs would not affect loan demand. Would we really not buy a car because the rate went to 1.5 from 1.3? Would we really stop buying houses if rates went to 5%? Raising the rate by 25 basis points would help savers, spur consumption, and get savers out of the speculative stock markets, decreasing volatility. Increased interest income would improve the wealth effect, especially for the half of the population that does not own stocks.
Janet Yellen, chair of the FOMC, stated that the global economy was uncertain, and this was the reason for holding off on raising rates. Unfortunately, staying at zero is counterproductive. Raising rates would strengthen the dollar, and this is a good thing. A stronger dollar means that goods and services become more affordable to Americans. This would increase demand, especially from the import perspective. As we buy more from overseas, production demand is increased abroad. This helps everyone. As a consumer nation, products become more affordable, and we buy more. Producer countries have to hire and open factories to produce more, creating jobs and opportunities abroad. That, in turn, would lead greater use of commodities, such as oil, copper, aluminium, steel, and agricultural products. Commodities prices would go up, due to the increased demand, and increased production would lead to additional greater demand. 95% of the world population lives outside the U.S. and it is their consumption that will generate wealth and opportunity in the global economy. Not letting this restructuring occur is detrimental to the U.S. and world economy.
U.S. Unemployment is around 5.5%, which economists consider to be full employment. Markets have doubled since the crisis. A strong dollar would increase our buying power and getting some interest from our bank accounts will help us save. In the meantime, Apple and Boeing would not suffer from a stronger dollar as they have pricing power and are at the top of the value chain. Our consumer companies would enjoy far greater product demand, which would more than offset the currency effect. Coca cola, Pepsi. Kimberly Clark, and Proctor and Gamble, Johnson and Johnson would sell more overseas as jobs get created there. Our agricultural products might be less attractive overseas based on price, but weather patterns and available land play a much greater role than currency, for grain exports or meats and vegetables. Oil prices would go up, but they will anyway, as smaller players go bankrupt and big players cut production. While Saudi Arabia can “afford” to lose money on oil, no North American company will keep an unprofitable operation going for more than a year. Shareholders won’t tolerate a company that loses money for an extended period. Production will be cut and prices will rise.
So, I don’t know what they are thinking. Higher interest rates encourage us to save. Monthly interest will give us more money. Banks and real estate investments do well as they can leverage the rates, make wise lending decisions, and grow. A stronger dollar gives us greater buying power and makes imports cheaper. It makes exporting countries like China and Germany more profitable. This increases demand for natural resources creating jobs and opportunities in Indonesia, Brazil, and all of Africa. This in turn will spur demand for U.S. Products worldwide. This is what needs to happen for economic growth to continue.
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