I know this sounds crazy. But I believe the low-interest-rate environment that has prevailed for months is actually killing the economy.
Hear me out…
In response to the credit crisis (which was caused by a low-interest-rate policy in the first place), the Federal Reserve dropped the Federal Funds Rate to between 0.25% and zero in December of 2008—where it has stayed for 30 months now. Treasury bills pay about zero today. The three-year, five-year and 10-year U.S. Treasuries; they all yield below the inflation rate.
Think about all the seniors (million of them) that were planning to receive interest income during their retirement years on money they worked hard to save. Those dreams are lost. Take a senior who has $1.0 million in the bank. The senior wants to avoid risk and thus opts for a 10-year U.S. Treasury paying three percent interest. That’s $30,000 a year. Take away personal income taxes and the senior realizes he/she can’t live off the interest $1.0 million in cash generates. Low interest rates are killing the retirement plans of millions of seniors.
Prolonged low interest rates in a country ultimately lead to money flowing out of the country to places where money can yield a higher return. Low interest rates are doing just that. By keeping interest rates artificially low, money is flowing out of the U.S. to other countries where cash can return a higher yield.
I’m all for a lower valued U.S. dollar. And today’s low-interest-rate environment is a perfect catalyst for the greenback devaluation. But long-term, this will come back to haunt us. Throughout history, no country has maintained its status as a world power when its currency has been devalued.
The widely recognized U.S. dollar, which 70% of world central banks have adopted as their reserve currency, was the backbone of the industrial revolution that followed World War II. The rapidly rising price of gold over the past 10 years is telling us that the U.S. dollar’s status as the world’s supreme currency is being unwound.
Have low interest rates helped the housing market? Of course not! If there is no confidence in the housing market (and how can there be with such a huge foreclosure inventory hanging over the market?), low interest rates will do little to spur the housing market (especially since banks are so tight at lending these days, even to qualified applicants).
As we lapse back into recession as I expect, with interest rates at zero, the Fed will be limited in its maneuverability for expansive monetary policy unless it continues to buy securities and expand its own balance sheet.
Finally, let’s not forget that artificially low interest rates have given the stock market a boom again. After all, with T-bills paying less than inflation, what alternative did investors have except equities? And when the bear market rally in stocks finally ends, and the market deflates again, what will happen to consumer and business confidence? It will collapse again with stock prices, making this next recession worse than the previous one.
Low interest rates for such a long-time…not sure it was such a good idea.
Michael’s Personal Notes:
Do you believe him?
While the market was up most of Wednesday, stocks fell later in the day when Fed Chief Ben Bernanke failed to indicate that any new stimulus plan was underway to help the economy. At a conference in Atlanta, Bernanke basically said that the Fed should maintain its monetary policy (record-low interest rates) but gave no indication that Quantitative Easing 3 was in the works.
Mark my words: if the U.S. falls back into recession, which I expect it will, the Fed will pull out all the stops to get the economy going again. That’s what the Japanese did in their “lost decade” after Japan exited its original 1990s recession and then fell back into it. The U.S. central bankers will do the same. They will flood the system with money. This will further depress the greenback, spark inflation and give rise to the price of gold—long-term trends my readers should continue profiting from.
Where the Market Stands; Where it’s Headed:
I’ve been thinking a lot about the stock market, and here are my short conclusions:
The credit crisis took the stock market much lower than most investors, stock advisors and economists predicted, bringing the Dow Jones Industrial Average to 6,440 on March 9, 2009. This was a decline of 55% from its high of 14,174 reached in October of 2007.
From the March 2009 market low, a bear market rally developed that brought stocks much higher than the same group could have ever thought possible. Many stock market indices were up 100% by the spring of 2011 from their March 2009 low.
As usual, most retail investors did not participate in the market rally that started in March 2009—they were too scared, too negative to jump into stocks. Retail investors started getting back into stocks in the fall of 2010.
By late 2010, early 2011, it became widely acknowledged that the Great Recession was over and we escaped the Great Depression Part II. Investors started jumping back into stocks. Stock advisors, as a group, turned decisively bullish back in November of 2010.
The stock market doesn’t reward latecomers. By that, I mean that the investors who got into the bear market rally late are paying the price today. Some blame the poor economic news for the market’s recent setback (Dow Jones Industrials down six percent from the April high). I simply say it’s the stock market doing its thing; a healthy correction in an extended rally.
I don’t believe that the bear market rally will simply give in to poor economic news and dissipate into the wilderness. People are very worried about the economy, stock advisors are now at their most negative position in seven months—all while I sit with a 30-year eye-witness belief that the stock market never does what is expected of it.
My timing has been uncanny, and I won’t get too cocky about it. Go back to my PROFIT CONFIDENTIAL issues of February and March of 2011. Back then, I was running an ad for one of our stock market services saying that the market would start to crash about May 2, 2011. Since that date, the Dow Jones Industrial Average is down 806 points and I’m sure there are some short sellers out there who have made a fortune from the recent market pullback.
But too many investors, stock advisors and analysts have turned bearish for me as of late. Unlike them, and while I’m bearish for the short and long term, I don’t think we should give up on the bear market rally just yet.
What He Said:
“Many of today’s consumers have purchased properties with very little down payment. They’ve been enticed by nothing-down, interest-only, second and third mortgages. Bottom line: The lower-interest-rate environment sucked consumers into the housing market big-time. And that will eventually cause us all problems.” Michael Lombardi in PROFIT CONFIDENTIAL, June 22, 2005. Michael started warning about the crisis coming in the U.S. real estate market right at the peak of the boom, now widely believed to be 2005.