Low Interest Rates Cannot Save a House of Cards
When is the price of some marketable good or service at or near zero? When either the supply of it is so plentiful that virtually any demand, no matter how great, can be satisfied. Or when no matter how large or small the supply of it may be, people’s demand for it is so low that nobody is willing to practically pay anything for it.
On Thursday, September 17, 2015, Federal Reserve Chair, Janet Yellen, announced that, once again, America’s central bank was leaving a key interest rate – the Federal Funds rate at banks lend money to each other overnight – at barely above zero. The Federal Reserve has manipulated and maintained this interest rate near zero for almost seven years, now.
Fed Policy Has Created Zero and Negative Interest Rates
When adjusted for inflation, the Federal Funds rate and the yield on one-year U.S. Treasury securities have been negative for almost all of the time since 2009. In real buying terms borrowed money has been either costless or actually given away with a positive real return to the borrower!
In other words, imagine that you borrowed $100 from someone with the promise that in one year you would return the $100 plus $2, or a two percent return on the lender’s money. But suppose that in a year’s time, you pay back the lender only $98.
That is what a negative real rate of interest means. After adjusting for inflation, the lender has less real buying or purchasing power than he did before with the principle of his loan. If you have lent that $100 but over the year price inflation has been, say, four percent, then when you get back $102 from the borrower (your $100 of principle and $2 of interest), this is not enough to buy at higher prices what the $100 had bought in the market before you lent that sum of money a year earlier.
– See more at: http://www.cobdencentre.org/2015/09/low-interest-rates-cannot-save-a-house-of-cards/#sthash.X8Gd2oBp.dpuf
