Bring Back Interest Rates!
Let interest rates rise. Better yet, let interest rates function in the marketplace, wholly independent of central bank attempts at rate-setting or targeting.
How? Not through a laughably small and slow process of Fed tapering, but through a wholesale and aggressive selloff of assets still polluting the Fed's balance sheet since it began aggressively those assets from commercial bank in 2008.
This was the critical point made by all three speakers at our event in Nashville this past weekend: interest rates need to rise before any true economic recovery can occur. The manipulation of interest rates by the Fed and other central banks causes untold distortions throughout the entire economy. Unless and until we address this problem, no fiscal or monetary policy changes will make much sense or have much salutary effect. Money and credit will continue to flow into less than optimal uses, investors will be forced to continue chasing yields in the casino equity markets, and Congress (plus other western legislatures) will continue to produce trillion dollar annual deficits without much worry about debt service.
Perhaps worst of all, the world will continue to believe a fairy tale: that the Fed effectively recapitalized US commercial banks in the 2008 crisis and through successive rounds of QE without pain or consequences. Are we really to believe the monetary base underpinning the world's reserve currency can be quadrupled in less than a decade without causing lasting damage? That gross overspending by Congress can be wished away simply by having the Fed provide a ready market for Treasury debt at miniscule interest rates? Or that interest rates should have no connection to the savings habits of society?
It all strains credulity, which is precisely why monetary policy relies so heavily on technocratic jargon and opaque processes: they want to confuse or bore us into not paying attention. And thus the can is kicked down the road, politically and policy-wise. That's how we became a high time preference society almost by stealth.
You can watch these engaging presentations by Dr. Robert Murphy, Carlos Lara, and myself here.
These excerpts from my talk attempt to remind the listener that none of this is normal, in fact quite the opposite. Not too long ago prosperous societies were based on the notion of capital accumulation, of producing more than they consumed, making the next generation better off in the process.
This is the fundamental and foundational change that has to occur. We need real, positive interest rates, meaning rates above inflation rates. We have to reward saving if we intend to have a growing or sustainable economy.
It is not exaggeration to say interest rates drive civilization.
They are the most important signals in an economy. Everything flows from them, because the cost of borrowing money effects the cost of almost everything.
This is the fundamental and inescapable starting point for building not only a real economy but a real culture. Every healthy society accumulates capital, every healthy society produces and saves more than it consumes and borrows. The human desire to leave something to future generations explains why all of us sit in splendor today, in this restaurant, enjoying conditions our great grandparents could not have imagined.
To do this you need actual real interest rates, market prices for money. Savers and borrowers, supply and demand, need to meet. We have a mechanism for this, it’s called the market. Without market prices you have socialism, the opposite of markets.
So why do so many otherwise free-market economists not object to monetary central planning?
The most important interest rate is the Federal Funds rate, the rate at which commercial banks borrow from each other overnight if they need to meet reserve requirements for their loans. The Fed controls this rate, or “targets” it, by manipulating the amount of reserves banks have in their accounts with the Fed. Banks with high reserves don’t much need to borrow from each other, so the Fed Funds rate stays low. And since 2008 commercial banks have received interest on excess reserves parked at the Fed, which encourages high balances and keeps rates low.
All commercial interest rates — e.g., the interest you pay on your mortgage — flow from the Fed Funds Rate on a cost-plus basis.
But when the Federal Reserve effectively keeps interest rates lower than they would be naturally, it creates a terrible disconnect between lenders and borrowers. And this disconnect causes unbelievable distortions throughout the economy. As David Stockman says, because of central banks there is no honest pricing of goods anywhere — we simply don’t know, for example, what a barrel of oil or a bushel of wheat or a Honda Accord should cost. The Fed has distorted the single most important price in the entire economy — the Federal Funds rate.