So from time to time on this blog I do finance pieces. I have been in the finance industry now over 30 years (yikes I am old). This is not financial advice only my financial opinion. You should consider multiple sources when making any financial decision and become as educated as you can. So the subject today is interest rates and how in the U.S. the federal reserve manipulates them to create false narratives in the economy.
Let me be clear here there are several factors in the U.S. economy that contribute to its overall health and well-being. The availability of credit though is a major factor and manipulating interest rates has a dramatic impact on financial outcomes. IMHO one of the biggest travesties in the U.S. economic model is the propensity to promote debt as a means to obtain assets. Of course there are times when you need credit for large purchases you don’t have the capital on hand to cover. Houses, vehicles, machinery that’s traditionally what credit was meant for. Now? You buy your lunch on credit.
The issue then becomes “how much is this purchase costing me?” you see it’s not the 8.99 for the sandwich and soda it’s the interest charge you incur on the purchase when (or if) you don’t pay off your credit card every month. Which, most Americans don’t do. The federal reserve’s rampant meddling with the federal reserve rate (the rate in which banks lend to other banks) has created horrible economic outcomes in the past.
There is a good article here https://www.forbes.com/advisor/investing/fed-funds-rate-history/ from Forbes that discusses the changes. Essentially what happens is the higher the interest rate the more valuable currency becomes. This is actually a viable method to combat inflation. Inflation often occurs when too much money is in the system or to little supply of products. Post pandemic we have both of these issues which is why the Fed is raising interest rates so much so fast.
Prior to the interest rate hikes over the last 2 years the fed rate was too low. You see the issue really is the U.S. federal government manipulates the value of their currency as a buttress against its monumental debt spending. Now all governments do this to a degree but the U.S. is on a whole other level. We had the prime rate in the U.S. at .5% for years and under 1.0% for a long time. Everyone knew that was way to low but the economy was humming along we had good times so no one complained much.
The problem with that approach is you put off the pain and here we are. Had the fed maintained a more pragmatic approach to interest rates, bringing them back to historic norms incrementally over the last 20 years we would have less inflation now. In the year 2000 the prime rate was 5.75% high by today’s standards but a reasonable rate in my estimation. Why? Because what it does is requires those who use credit to make purchases to think carefully as the interest expense on the debt is high. It’s a big commitment financially to borrow anything at 5% IMHO.
So how do we get out of this manipulation? You can do rate caps but that’s another artificial means to an end. You do what’s called settling the rate market. You get to a point say 4% and you do not raise or lower the rates for 2 full quarters to see how the economy adjusts. The problem now is you have the government changing rates every month. They are doing this to manipulate the economy due to severe inflation. I get why they are doing it but had they not kept interest rates artificially low for nearly a decade the huge increases now wouldn’t be necessary.
I know all of this is fairly dry and not something most of you will probably want to read through. Here is the net bottom line. Leave interest rates alone for 6 months, let things play out see how the economy does. You then adjust .25 -.50 % from there and then wait again. Market adjustments take more than a quarter to take hold and because interest rates were so artificially low for so long it’s going to take well into 23, if not 2024 to flush out the current inflationary situation we have.
Hang in there and remember, your personal economy is paramount. Have a 6-month emergency fund, secure your income sources by diligence at work, and keep an eye on your spending.
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