Investments and Interest Rates

For years now, interest rates have been low. That was caused by two things happening simultaneously – a serious recession bordering on a depression, and the near-failure of the American financial system. We need to understand that the latter caused the former. To determine cause of the latter, we must observe behavior of the primary participants in the economy of that time.

Those would be the movers and shakers in both the banking and investment industries. They were all about expanding their domains, making money, and attempting to revamp the system so they could make even more money. They even lobbied congress to ease financial regulations, especially those affecting their own industries.

They were successful in those efforts. The Glass-Steagall Act was rescinded. Banks could now own investment companies, and investment firms could now own banks. Same became true of real estate corporations. With little regulation and a whole lot of greed, the three industries had a feeding frenzy and outdid themselves with greed and overreach. The result was the crash of the mortgage industry, real estate industry, banking and investments. All were intertwined with one another in an incestuous knot of orgiastic pleasure. For a while they were unaware of the trouble they were in until it was too big to ignore. But the collapse of the financial system was upon us all.

Politics made the problem worse. Political parties played the blame game and blocked progress toward solutions. This behavior almost killed the entire economy. Finally, cooler heads prevailed and President Obama’s repair solutions were enacted. These could have been better but politics restricted that from happening. Regardless, the economy’s tail spin was halted, and slowly we began the arduous task of rebuilding the banking, investment, mortgage and real estate industries.

During this entire time few investments were attractive due to high risk levels. As a result, investment returns were nil. So too, interest rates. This led to an enormous stockpiling of cash with nowhere to go. Interest rates almost turned negative – that would mean savers would pay banks for storing their unused dollars! That did not happen in the USA, but it did happen elsewhere in the world.

With interest rates near zero, companies and investment firms with gobs of cash bought other companies to boost financial returns. Merger mania resulted. Larger and larger companies resulted. More and more real estate was owned by fewer and fewer people and organizations. The economy was entering still another vague phase which warped values and investment returns.

Still, interest rates remained stubbornly low. Gnashing of teeth begged for higher interest rates so banks and investment firms could make more money without buying and selling companies. The reality, however, was a surplus cash hoard of over $7 trillion, maybe $9 trillion. Mergers were the only game in town.

And time. Time passing begins to have an effect. Slowly new investments came into being, new inventions and new companies sprang up and technology revolutionized the business landscape.  New opportunities to make money appeared and business began to grow again.

With this growth came expanded use of money and the trillions of unused dollars in the economy began to be absorbed in new enterprises. Interest rates bubbled slightly upward. With renewed global economic activity, interest rates have bubbled upward a little more vigorous lately. Still they are low.

Now the Federal Reserve warns of possible inflation concerns and in response, pushes interest rates up just a bit. Others are watching closely. They say they want the higher interests so they can earn more money on their unused cash. But with each threatened upward tick of interest rates, the stock markets shudder and slump. Investors are saying that higher interest rates will compete with investment dollars and stock sales will fall.

This is mostly nonsense but it could happen that way. It all depends on how all of us in the economy respond to higher interest rates and if that affects our consumption of goods and services. If the effect is nil, then interest rates will continue to rise and stocks will continue to be traded. Stock values will fluctuate based on their intrinsic corporate value and profit margins. Interest rates will have little affect on them.

So, instead of crying ‘wolf’ yet again, interest rate decriers should calm down and observe what happens before reacting. Interest rates are abnormally low and need to rise to 3 or 4% on routine savings. We have a long way to go for that to happen; and it won’t happen until mortgage and auto loan rates return to the normal 5 to 8% region.

We have a global market to serve – sell goods to, sell services to. We have ample labor pools to do the work. We have the cash. The only thing missing is willingness to take on risk.

In the final analysis, interest rates and investment returns are the return on our risk taking. So if we want the dollars, we must take the risk.

May 4, 2018