Whose Interest?
Why most of us should hope the Fed holds rates steady
The latest inflation news was good enough to spark another rally on Wall Street as market bulls (almost everyone in this “everything bubble”) are all but certain the Fed will begin cutting rates again next month. This is in spite of the following: 1) The Consumer Price Index (CPI) is still almost a full percentage point above the 2% target, 2) Unemployment is still relatively low (4.3%), and 3) Housing prices are still rising at over 5% per year.
What’s the rush? Consumers are still worried about inflation — especially housing prices. But never mind that. Capitalists are addicted to monetary heroin in the form of low interest rate loans of Federal Reserve Notes (dollar-denominated debts of US taxpayers) and other stimulants. The kingpin pushers (Fed Chairs Greenspan, Bernanke, Yellen, and Powell) actively promote their story that easy money policies help average Americans avoid the pain of recession.
Apparently, it’s too much to expect economists beholden to politicians to admit they cannot deliver a free lunch. Both point to statistics such as the CPI, unemployment rate, and Gross Domestic Product (GDP) as evidence of success to date. But there is another side to the story. Other trend data for statistics such as our national debt, wage growth, and the gini coefficient (measure of income inequality) show that the celebrated gains have come at great expense to low income households.
I have argued that our system has worked much better for the wealthy than for the poor; I have also proposed remedies. Unfortunately, there is no painless solution, and the longer it is postponed, the more painful any correction will be. Nevertheless, if we open our eyes to what is really going on and stop making the situation worse, we may find a way to create a responsible and equitable economic system.
Just before the Fed finally lifted rates from the zero bound in 2022, I called for aggressive action to address high inflation. This January, I criticized the Fed’s commitment to positive inflation that keeps the financial vultures circling over heavily indebted workers. Now I feel obligated to point out that from a consumer standpoint, a return to lower interest rates is terrible news, because it means that capitalists are not done picking our pockets.
Other writers here on Medium have noticed that most of our fellow Americans aren’t having fun yet (and that it has nothing to do with the relatively recent run-up in interest rates). I’m also not the only one who has warned that the “everything bubble” inflated by loose money is a disaster in the making. I’ll take confirmation of my contrarian views wherever I can get it, but it is especially gratifying to find a really good book with tons of source materials that support my case. That book is The Price of Time by Edward Chancellor.
Here are lessons from The Price of Time that may persuade you to join me in hoping the Federal Reserve cavalry holds its horses, at least for now.
We’ve been conditioned to take interest rates as given by bankers who are able to control the supply. This is normal to us but it is quite artificial. Interest, as Chancellor explains, is the “time value of money” (p. 28). It is the exchange rate of current vs. future consumption that emerges in a free market that reflects variation in “time preference” — the value we place on immediate or deferred wants and needs.
“Interest” came to represent the cost of capital because it also implies a stake. Moreover, without interest there would be no capital and hence no capitalism, because capital is technically defined as the present value of a stream of future income discounted by its cost (or interest rate). No wonder capitalists are obsessed with interest rates!
Interest rates, then, determine asset values, and we learned 400 years ago that “when money is dear, land is cheap, and where land is cheap, money is dear” (p. 31). This has not changed. In other words, lower mortgage rates will not lower the cost of real estate; they may in fact cause rents to rise.
Over 300 years ago, we learned about the dangers of fiat money from Scot grifter John Law and his Mississippi Company scheme in France. In 1715, Law persuaded the regent controlling royal tax policy for the child king Louis XV that printing money would solve his war debt problems. It worked for the King and made Law the richest man in the world, but by 1721 the bubble popped, wiping out investors and leading to riots and his own exile (pp. 48–57).
In the mid-nineteenth century, Walter Bagehot, renowned editor of The Economist, observed that easy money led to “yield chasing” by investors seeking higher rates of return. Some of their ventures will be unprofitable, he said, and a few of them will be “absurd” (pp. 63–68). While known for his rule that central banks should act as lenders of last resort, subsequent practice has been to ignore his condition that such loans be short-term, require high quality collateral, and charge high rates of interest. It is also worth noting that he considered deflation a normal part of trade cycles (p. 76). Cambridge economist Alfred Marshall also challenged the common assumption that deflation is disastrous; he said it raises workers’ standard of living and reduces wealth inequalities (p. 99).
Central banking was turbocharged early in the 20th century as the US took center stage. Under pressure from England and sharing their fear of deflation, President of the New York Federal Reserve Benjamin Strong committed to a policy of price stabilization that, beginning in 1924, led to sharp declines in interest rates and a booming stock market (pp. 86–87).
Most historians and economists blame the Great Depression on a tight money response to the market crash in 1929; few focus on the easy money policy that inflated the bubble and set these events in motion. Chancellor credits Austrian economists with analysis that highlights the folly of attempting to control prices. In 1928, Friedrich Hayek wrote that monetary policy stimulus aimed at price stabilization would expand output as costs of production fall, making “a later fall in prices with a simultaneous contraction of output unavoidable” (pp. 95–96). He echoed Marshall’s argument that deflation resulting from improved productivity is good and that deflation occurring in a financial crisis is a symptom, not a cause, of economic malaise (p. 100).
In the late 1980s, the Bank of Japan similarly focused on prices while ignoring an explosion of credit in response to their decision to toy with foreign exchange markets by holding interest rates below the GDP growth rate. When inflation took hold, they quickly raised rates, but this left enormous debts that prevented recovery even after rates were brought down to near zero. The result was not one, but two “lost decades.” (pp. 106–07).
Meanwhile, our own central bank, which had won its own bout against inflation in the early ’80s, committed the same error (ignoring debt) when Chairman Alan Greenspan committed to a policy assuming they could intervene at will provided inflation was low. In the ’90s, the Fed held interest rates below the rate of GDP growth, just as the Bank of Japan had done a decade earlier. This of course led to the greatest bubble in US history — the dotcom bubble of 2000 (pp. 110–11).
Not to be outdone, Ben Bernanke, who took the Fed helm in 2002, cut interest rates to below the GDP growth rate again and left them there for 5 years. Inflation stayed low, but easy credit created a housing bubble that popped in the Great Recession of 2008 (pp. 112–19). What followed was the US’ own lost decade, as a series of unprecedented interventions by the Fed failed to stimulate economic growth. This is because, as the Bank of International Settlements (BIS) Chief Economist Claudio Borio explained, the debt accumulated in the boom acted as a drag on consumption. Lower rates are no cure, because they simply create even more debt (pp. 131–35).
In addition to reliably creating boom/bust cycles, easy money policies create perverse incentives that destroy wealth via misallocation of resources. The BIS found a correlation of low interest rates with “zombie” companies, which supports Bagehot’s warning that good times bring out bad investment schemes. Their explanation is that lowering the hurdle for return on capital leads to lower productivity (p. 153).
Low rates (debt cheaper than equity) also enable financial shenanigans like mergers, leveraged buyouts, and stock buyback schemes that — supposedly to enhance “shareholder value” — primarily result in less competition and weaker companies, as firms find it cheaper to artificially boost share prices instead of making long term investments in operations. In the US, corporate investment as a percentage of cash flow fell to an all-time low in 2014. In 2015, the BIS warned that such activities reduce overall economic growth, yet central banks continued the practice (pp. 156–71).
Real savings (e.g., earnings set aside for future consumption) were decimated by low interest rate policies (aka “financial repression”) early in this century, and savings rates in the US actually turned negative in the aftermath of the Great Recession. Americans learned to save more money to offset lower returns, but they find it increasingly difficult to save enough for a comfortable retirement, and (very rare) pensions are in very precarious financial condition (p. 190–98).
Income inequality is another consequence of low interest rate policies. Serial bubbles have inflated assets of the wealthy while the resulting corrections have left workers in debt and facing limited employment opportunities and lower real wages. Attempts by central bankers (e.g., Janet Yellen, who succeeded Ben Bernanke as Fed Chair) to resuscitate their national economies failed to raise wages but did raise the cost of living for most workers (pp. 206–15).
Finally, workers are fleeced by the financial repression of monetary policies that hold interest rates on government bonds below the rate of inflation. This amounts to a negative real interest rate that allows payment of public debt with devalued currency, but it also erodes the purchasing power of wages (p. 290).
For this essay, I’ve selected numerous central bank failures identified by Chancellor. All of them exhibit a bias toward increasing the money supply and thereby lowering the cost of capital. It is, as they say, the nature of the beast. However, it does beg the question of why we allow our elected and appointed officials to keep trying the same thing while expecting us to believe they will achieve different results.
The moral of this story is captured by the author’s quote from Hayek’s book The Road to Serfdom warning against activist monetary policies:
“[T]he more we try to provide full security by interfering with the market system, the greater insecurity becomes; and, what is worse, the greater becomes the contrast between the security of those to whom it is granted as a privilege and the ever increasing insecurity of the underprivileged.”
Chancellor is not an economist and his book stopped short of pitching a specific fix, but his research did lead him to suggest an alternative to the global dollar standard that seems worth exploring: Central bank digital currencies backed by government bonds whose issuance is limited to the trend growth rate of national economies (p. 312). Such a mechanism would make monetary policy respond to organic growth (determined by a free market in savings and investment) — just the opposite of current practices that employ policy instruments to drive growth in the real economy.
