Wednesday, February 3, 2016

The sin of low interest rates – the Fed should just raise rates and forget what happens to the stock market

Low interest rates encourage investment in overcapacity.
Low interest rates encourage speculation in stocks.
Low interest rates encourage consumption which pulls future demand into the present.
Low interest rates encourage the Federal Government to become an intermediary.
Worst of all, low interest rates reduce money velocity.

The non-banks otherwise known as shadow banks, insurance companies, pension, brokers and dealers, Wall Street bond houses, finance companies, and money market funds, all reduce their economic activity.  Money lies fallow in the banks, inert, doing nothing.  It is a myth that banks are intermediaries.  They do not and cannot lend out deposits.  The non-banks are intermediaries and they need to attract the money sitting inert in the banks using higher interest rates as bait.

To reverse the decline in money velocity interest rates need to be increased.  But the Fed model as simply stated by Bill Gross, “…higher short rates slow economic growth/temper inflation, and that low (or negative) interest rates do just the opposite.”, won’t allow the Fed to raise rates further in the slowing economy.

Additionally, the Fed gospel is the wealth effect.  Which I believe is true.  People spend more money in a rising stock market and spend less in a declining stock market.  This further doesn’t allow the Fed to raise interest rates.

I think the Fed should just go for it and raise rates.  Not back to normal.  Just maybe 2 to 3%.  The reaction will be painful but not raising rates just kicks the can down the road.  The negatives of low interest rates continue.  Nothing gets better.

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