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This
week's wild actions on Wall Street should serve as a stark reminder that few
investors have any clue as to what is really going on beneath the surface of
America's troubled economy. But this week did bring startling clarity on at
least one front. In its August policy statement the Federal Reserve took the
highly unusual step of putting a specific time frame for the continuation of
its near zero interest rate policy.
Moving
past the previously uncertain pronouncements that they would "keep
interest rates low for an extended period," the Fed now tells us that
rates will not budge from rock bottom for at least two years. Although the
markets rallied on the news (at least for a few minutes) in reality the
policy will inflict untold harm on the U.S. economy. The move was so
dangerous and misguided that three members of the Fed's Open Market Committee
actually voted against it. This level of dissent within the Fed hasn't been
seen for years.
Many
economists have short-sightedly concluded that ultra low interest rates are a sure fire way to spur
economic growth. The easier and cheaper it is to borrow, they argue, the more
likely business and consumers are to spend. And because spending spurs
growth, in their calculation, low rates are always good. But, as is typical,
they have it backwards.
I
believe that ultra-low interest rates are among the biggest impediments
currently preventing genuine economic growth in the US economy. By committing
to keep them near zero for the next two years, the Fed has actually
lengthened the time Americans will now have to wait before a real recovery
begins. Low rates are the root cause of the misallocation of resources that
define the modern American economy. As a direct result, Americans borrow,
consume, and speculate too much, while we save, produce, and invest too
little.
It
may come as a shock to some, but just like everything else in a free market,
interest rate levels are best determined by the freely interacting forces of
supply and demand. In the case of interest rates, the determinative factors
should be the supply of savings available to lend and the demand for money by
people and business who want to borrow. Many of the beneficial elements of
market determined rates are explained in my book How an Economy Grows and
Why it Crashes. But allowing the government to determine interest
rates as a matter of policy creates a number of distortions.
It
was bad enough that the Fed held rates far too low, but at least a fig leaf
of uncertainty kept the most brazen speculators in partial paralysis. But by
specifically telegraphing policy, the Fed has now given cover to the most
parasitic elements of the financial sector to undertake transactions that
offer no economic benefit to the nation. Specifically, it will simply
encourage banks to borrow money at zero percent from the Fed, and then use
significant leverage to buy low yielding treasuries at 2 to 4 percent. The
result is a banker's dream: guaranteed low risk profit. In other words it
will encourage banks to lend to the government, which already borrows too
much, and not lend to private borrowers, whose activity could actually benefit
the economy.
This
reckless policy, designed to facilitate government spending and appease Wall
Street financiers, will continue to starve Main Street of the capital it
needs to make real productivity-enhancing investments. American investment
capital will continue to flow abroad, denying local business the means to
expand and hire. It also destroys interest rates paid to holders of bank
savings deposits which traditionally had been a financial pillar of retirees.
In addition, such an inflationary policy drives real wages lower, robbing
Americans of their purchasing power. The consequence is a dollar in
free-fall, dragging down with it the standard of living of average Americans.
Until
interest rates are allowed to rise to appropriate levels, more resources will
be misallocated, additional jobs will be lost, government spending and
deficits will continue to grow, the dollar will keep falling, consumer prices
will keep rising, and the government will keep blaming our problems on
external factors beyond its control. As the old adage goes, "insanity is
doing the same thing over and over again and expecting different
results."
Peter Schiff
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