social network for conservatives
Robert W. McGehee
With passage of the Humphrey-Hawkins Act in 1978,
Congress forced our Federal Reserve (“Fed”) to assume
a dual mandate: 1) to maintain a stable currency,
and 2) to stimulate employment.
This second mandate is not found in the central banks of rival
developed economies (most notably the European Central Bank).
I believe it is very destructive in the long run to our middle class
A large, thriving, and growing middle class is what has made
the United States unique and powerful among nations.
This broad economic segment includes lower middle, middle
and upper middle income classes. In the past, our government
fostered policies that enabled citizens to move into these middle
classes, and to give future generations a chance at an even better
economic life than that of the parents.
The proliferation of 401k accounts, while an admirable idea,
has had a paradoxically unintended negative consequence.
For the past 25 years, there has been constant political pressure
on our Fed to stimulate the equity, bond, real estate and commodity
markets at the tragic expense of destroying our country’s ethic of thrift.
This has been done under the guise of keeping rates low to
Speculative investment markets are not meant for people who
cannot afford to lose their life savings. The vast expansion of
equity ownership via 401k’s has created a political bias to constantly
pressure our Fed to intervene and stimulate equity markets by
suppressing interest rates. This has forced most traditional “savers”
out of safe investment (such as CDs, Money Market accounts, etc.),
and into mutual funds and other higher risk investments.
By some estimates, there remains up to $1 Trillion in traditional
consumer savings in this country, in addition to the $2 Trillion in
cash on corporate balance sheets. If the Federal Reserve were
currently maintaining its base Fed Funds rate at a minuscule 2%
(to match a conservative inflation estimate), citizens and corporations
would have an additional $60 Billion in annual pre-tax interest income!
This money would be spent, providing significant stimulus to our economy.
Instead, our government maintains its base Fed Funds Rate artificially
low, nearly zero, in hopes that the equity and real estate markets will
recover and appreciate. Even if these low rates have recently made our
401k values appreciate 10-20%, it is doubtful that this stimulates people
to spend money. $60 Billion in real interest income would have a much
larger impact on consumer spending than does the psychological lift of
401k values appreciating (especially since we know these values are volatile).
The argument is then made that keeping rates low will stimulate
borrowing, by lowering debt payments. Anyone with a basic
understanding of finance knows that of the three primary considerations
in term credit lending or borrowing decisions (cash flow, term of loan,
and rate), interest rate has the LEAST impact, by a wide margin.
In other words, if credit analysis reveals that cash flow is insufficient,
no term or rate will compensate. If cash flow is marginally sufficient,
the term of a loan has a vastly larger impact on payment than does rate.
We have empirical evidence that this low rate environment is not
favorably impacting borrowing or lending. Our banks are being
rehabilitated at the hidden expense of middle class savers and taxpayers.
This is being accomplished by allowing banks to borrow from the Fed
at nearly zero cost, which funds are reinvested in Treasury bills and
bonds at 2-4%, almost risk free (the only risk being the government’s
future inability to tax us to fund the bills and bonds). Essentially,
banks are borrowing from taxpayers at nearly zero cost, and re-lending
to taxpayers at 2-4% - what a deal for them!
Until banks are forced to pay 2-3% for funds (to reflect real inflation),
why would they ever want to go to the effort and risk of underwriting
loans on a large scale to small businesses and homeowners?
They can receive a 2-4%, virtually risk free return under the above model.
If our Fed were currently charging banks a more appropriate 2-3% cost
of funds, savers would see their savings rates rise to at least those levels,
and banks would have to find qualified borrowers to pay 6-8% for quality loans.
Over the past 50 years, our middle classes have come under unrelenting
economic, political and moral attacks from a government that appears to
be increasingly hostile to the very people who have made us the greatest
nation in history. The active destruction of thrift, by suppressing savings
rates and subsidizing reckless risk, is one of the most egregious examples
of this trend.
Our legislative and executive branches are exerting undue influence
over the policies of the Federal Reserve, under the guise of “stimulating
employment.” What they are really doing is stimulating one “asset bubble”
after another - stocks, real estate, commodities, bonds... all at the expense
of a stable dollar.
We need to demand that our central bank, the Federal Reserve, refocus
on its core mission - maintenance of a stable, strong and predictable currency.
Companies do not hire, businesses do not borrow, and banks do not lend
because rates are low. These positive activities occur due to consumer
demand and subsequent business productivity, which are fostered by
rational monetary policy.
Interest rates should not be used in a vain attempt to lead the economy
forward; they should follow economic activity. Higher interest rates
would stimulate spending by savers, and encourage banks to make real
loans to productive businesses in response to this demand. This alternative
would be far superior to lending our tax dollars to the banks at nearly
zero cost, so they lend it back to us in Treasury bills at 2-4%.