Lack of Interest

One of the major reasons our economy is so messed up is lack of interest.  Not lack of individual interest.  Near zero of interest rates at banks.

The reason banks now offer almost nothing in terms of interest is that the rates are not set by market conditions.  Instead, interest rates are set by the Federal Open Market Committee (FOMC) which is part of the Federal Reserve Bank.

In a free market, banks, investment houses, and others would compete to have you deposit your savings with them.  The more demand for deposits, the higher the interest rates.  On the other side of the coin, demand for loans would also either increase or decrease interest rates.  This way, interest rates were regulated by the supply and demand of the entire economy.

Interest rates in this country have not been determined this way in a VERY long time.  Really not since before World War One and the creation of the Federal Reserve Bank in the United States.  Since that time, the Government, not the free market, have determined interest rates.  Decisions about where to set the interest rate are one of the main ways the Government attempts to manipulate the economy.

The FOMC uses interest rates mainly to either battle inflation or try to increase economic activity.  In the early 1980’s, when inflation was viewed as “out of control”, they raised interest rates to previously unheard of levels, well over 10% per year.  Since about 2006 they have put interest rates at or near Zero in attempts to increase economic activity.

With interest rates set at almost nothing, there is little to no incentive to save money.  People are generally risk averse.  You save money not just because you want it to be there in the future, but you also want that money to work for you by gaining interest.  If there is no way to make a gain safely, people start to look for riskier and riskier investments.  Today almost all of this money has been put into the Stock Market, as people think it is the only way nowadays to make their savings grow.

Low interest rates mean that money is moved from Investment to Speculation.  This is the root cause of almost every single financial crisis in history.

Low interest rates also mean that people and institutions borrow more and more money.  They view the cost of borrowed money as almost nothing.  Trouble is that most of them borrow the money on variable interest rates, meaning that the cost of the loan is not “locked in”.  So as interest rates go up, they find themselves owing a LOT more money than they ever planned to pay back.  And this is how people and even Governments find themselves bankrupt when interest rates rise.

Today the FOMC knows that it has painted itself into a corner.  So much money is owed by both the Government and individuals that it can’t raise interest rates without risking severe bankruptcies.  So it can’t raise interest rates to reduce speculation and move people back into investments.

So increasing speculation will eventually end the way that it almost always does, with a financial crisis, one that the FOMC will not be able to do anything about.

What to Do

Government control of interest rates did not start recently.  It’s been in place for more than a hundred years.  Drastic change from the current situation is warranted, but it has to be done carefully and slowly.  We should return to predominantly free market conditions, but we should try to do so in an orderly fashion.

Unfortunately, I have absolutely no faith that this is going to happen.  Almost everyone, individuals as well as Government, wants interest rates to stay low.  So they will remain low until there is a crash.

Again, recognize that the world is currently engaging in a speculative mania of epic proportions.  It involves Government, banks, corporations and individuals.  The best way to protect yourself is to stay out of it.

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