Keeping Interest Rates Low

Many people believe the Fed should keep interest rates low because low interest rates make it easier to service debt and they allow restructuring of the financial industry to occur more quickly.  Still others point to the fact that low interest rates reduce the cost of financing government deficits and make the rise in government debt-to-GDP ratio more tolerable.

There are several problems with keeping interest rates low, however:

  1. Below market rates of interest; i.e., government induced prices for money, encourage borrowing.  In fact, they encourage borrowing for projects that wouldn’t be undertaken if it weren’t for the low cost of money.  In short, they induce a misallocation of capital into projects that might not otherwise be viable were it not for the cheap money.  What’s worse is that if/when interest rates go up, many of those projects that were relying on cheap money will fail.
  2. Although government debts and deficits are more easily financed, we don’t need more government debts and deficits.  Governments are least productive with the money they spend and the debts they incur.  Private enterprise is a far better place to invest money—it stands a greater chance of earning a profit and providing sustainable jobs.  Governments do not earn profits!!!  They consume capital.
  3. Low interest rates encourage more government borrowing, which crowds out private borrowing.  Only a few private entities can borrow money as cheaply as governments can.  When private enterprises can’t borrow, growth can be stunted.  Profits can shrink and along with shrinking profits come lower taxable incomes and lower standards of living.
  4. Low interest rates promote the extension of credit which is an expansion of the money supply; i.e., inflation.  In time, inflation (which is a component of interest) causes interest rates to rise.  When rates rise, much of the misallocated capital becomes unsustainable and is defaulted upon.  A contraction occurs until the markets readjust to the new higher rates and less capital, or more money is printed, which repeats the expansion/contraction cycle.
  5. As long as governments are allowed to manipulate the price of money (interest rates), they will control it, use it to further their own means, expand their roles in our lives, and misallocate resources away from productive purposes, businesses, consumers, and profitable sustainable job-producing ventures and in to make-work projects, wars, and increased infringement of individual rights.
  6. When interest rates are held low, there is little incentive to save.  And it is savings and capital investment that is needed to spur productivity and raise standards of living.  A back-hoe is more productive (and requires more capital investment) than a shovel.
  7. When interest rates are held low, it isn’t possible to get rich by saving and investing in the long-term future.  And because low interest rates can lead to price inflation in the long run, everyone is forced to become short-term speculators.    With low interest rates, people turn to rising commodity prices for a reasonable rate of return (or protection from rising commodity prices).
  8. When interest rates are low, retired folks, especially, are squeezed because of their lower interest income, making them more dependent on Social Security; i.e., government programs.  In time, people become dependent on government programs and learn to turn to government for financial help and solutions to social problems.
  9. As government lending and spending grow, price inflation increases and debtors gain while creditors lose.  In time, this creates a massive transfer of wealth from savers (creditors) to spenders (debtors).  The emphasis in society shifts from saving and investing to spending and consuming.  Such a society can only last so long—until the wealth is consumed.

I, for one, think that interest rates should be determined by the market rather than by government edict and manipulation.  Government should not be in the money business.  They misallocate resources in whatever they touch.  For thousands of years, gold and silver were used as money the world over and interest rates (where interest was allowed by governments and/or religion) was the payment for the use of money over time.  Isn’t it time we get government out of the money business and allow the markets to do what they do most efficiently—supply money for projects that produce the greatest return to mankind?

Robert Jackson Smith

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