Wednesday, April 7, 2010

Zero % Interest Rates Hurt

I saw Laura D’Andrea Tyson, Professor at UC Berkley, Haas School of Business, on CNBC today, and in commenting on the Federal Reserve Board, Open Market Committee minutes released today she said “now I think, as far as the rates are concerned, I am one of the people who really believe that the slack in the economy remains considerable, there is no sign of inflationary pressure, if you take a kind of Taylor like rule to what the Federal Reserve should be doing on interest rate policy, there is no argument in my mind for an increase in rates, and that is why they continue to use the extended period language. I think it is the right thing to do”.

I can’t disagree with her more. The Fed’s zero interest rate policy (ZIRP) benefits two groups; banks and politicians. Banks, because they borrow funds more cheaply than would otherwise be the case and reinvest in Government backed securities, thereby creating riskless profits by the boatloads that can then be apportioned between bonuses for employees and reserves. Since banks have all but eliminated their dividends, even shareholders get left out. Politicians, the faces behind the world’s largest borrower, the U.S. Government, also borrow at rates lower than would otherwise be the case. This allows them to spend beyond reason, and probably the ability to repay, in order to insure their own re-election.

Who then pays the price? This country’s savers and investors, that’s who. This group is forced to choose between no return on their hard earned savings or being forced to take more investment risk than might be reasonable, all because they had the discipline to put away funds for the future and not spend themselves into bankruptcy. This group is forced to take the Government’s $250 bonus for social security recipients, when if safe investments yielded even 2% annually, a $25,000 nest egg would return $500 in a year, twice as much. As far as the economy is too weak to support an interest rate increase argument, I think if investors and savers earned more, they would spend more, and undoubtedly in a much fairer and wiser fashion than our Government representatives.

It is time to normalize interest rate policy in this country. The Chairman of the Federal Reserve Board has stated before congress, the crisis is behind us. In that case, Mr. Chairman, it is time to raise rates now.

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