Back in the 1980s, Bundesbank president Otmar Emminger made the essential and true assertion that the dollar “is the most important price in the world economy.” Implicit in Emminger’s point was the simple reality that with every currency in the world having a vague or explicit definition in terms of the dollar, when the latter fluctuates, so do the money prices of all goods and investments globally such that investment and trade mismatches occur.
And if the dollar is the world’s most important price, the cost of credit comes in a close second. When interest rates are allowed to float free of central bank intervention, the happy consequence of such a market-driven price is that in reaching natural levels conceived in the marketplace, the supply of and demand for credit is equalized.
All of which brings us to a Wall Street Journal article from last week, “Fed’s Low Interest Rates Crack Retirees’ Nest Eggs”, which revealed in living color the problems that result from central bank meddling in the credit markets. Thanks to the Fed’s naive efforts to create an artificial credit outcome through its imposition of a below-market rate for short-term credit, the latter has paradoxically become less plentiful.
The culprit of course is central bank fiddling, and while this writer has no opinion on whether rates should be high or low, the view here is certain that whatever the proper cost of credit, the Fed can’t possibly know it. As such, the rate set by the Fed is bringing great harm to the savers whose savings would in a normal world be supplied to job-creating entrepreneurs.
The aforementioned Journal article specifically cited the struggles of Forrest Yeager, a 91-year old World War II veteran who, thanks to short-term CD rates paying less than 1% interest, has been forced to dig deeper into his principal in order to get by on a monthly basis. On its face the story is a sad one considering how this elderly man faces retirement uncertainty at an age when finding new work is unrealistic.
The Fed never considered individuals like Yeager when it used rate machinations to soften the blow for banks (NYSE:XLF) and borrowers who made poor decisions. Ever oblivious, the Bernanke Fed forgot that for every economic act there is a tradeoff, the tradeoff is often negative, and Yeager’s difficulties reveal how very cruel have been the Fed’s credit interventions.
Of course Yeager’s story is but a small part of a bigger, and very negative story concerning the Fed’s activities. To see how Yeager’s pain is all of ours, we must consider the broader implications of artificially low interest rates.
For one, while the Fed can set any rate it wants for short-term credit, there’s no law saying that those with credit to offer have to do so. Indeed, due to these low rates it’s fair to assume that we can extrapolate the Yeager’s across the economy; individuals unable or unwilling to save with less than 1% as the reward such that there’s less credit available than the Fed’s “loose money” stance would suggest.
Just as price controls on apartments, food and energy lead to shortages of all three, when government backed entities seek to control the price of credit as the Fed is trying to do, if the central bank shoots too low as this Fed has surely done (0% is unrealistic under any economic scenario), the certain market result is a shortage of credit. As evidenced by the clamoring among small businesses for more credit, it becomes apparent that the Fed has played a certain role in making what might be plentiful if market forces were allowed to prevail, dear.
So not only is saving unrealistic for many due to the Fed’s credit hubris, individuals like Yeager presently find themselves in a position where they have to access principal savings just to get by. To clarify, men like Yeager are forced to actually remove growth capital from the banking system in order to sustain their most basic standards of living.
Basically the economy loses twice under such a scenario. Artificially low credit rates set by the Fed first drive away savers unwilling to lend at distorted rates, and second, those on fixed incomes who can’t get by with low interest rates are forced to pull even more credit from the system in favor of near-term consumption. Though it labors under a stated intent to make credit easy, the Fed’s actions are actually making it difficult to access.
The answer to this problem is happily quite simple: the Fed must float the short rate for credit that it currently sets, and in doing so, let rates rise to the level that equalizes the needs of lenders and borrowers. If so, those with credit to offer will soon re-enter the marketplace as rates mirror market realities, after which a tight market for credit will logically become easier such that lending to businesses in need of funds will increase.
John Tamny is a senior economic advisor to Toreador Research & Trading, a senior economist with H.C. Wainwright Economics, and editor of RealClearMarkets and Forbes.