Excuse me, but what is so offensive about higher interest rates?
If we get real about it, we’ve all been expecting higher rates for at least a year. The question wasn’t “whether” but “when.”
Now we know.
It was April. Always the cruelest month for poet T.S. Eliot, it’s now the cruelest month for investors.
Judging by market action in April, you’d think higher interest rates were closely related to Ebola. Bonds of all kinds and maturities fell in value. The average U.S. intermediate government bond fund lost 3.33 percent in the month. Of course, you expect bonds to decline when interest rates turn up. It’s a matter of algebraic necessity.
The cruel part was the 1.98 percent decline in the average U.S. equity fund and the corresponding 2.35 percent drop in the average international equity fund even as the month filled with upward earnings surprises.
Perhaps we should give the talking heads some credit for this. There was much public hand wringing about higher interest rates and the damage they can do to the economy.
In fact, we should greet rising interest rates with enthusiasm, not fear. Higher rates are a sign of health. Our economy is ready to come out of the Federal Reserve Intensive Care Unit.
Here’s why we should cheer higher interest rates.
First, the rumors you have heard are true. There are actual people out there who lend money rather than borrow it. These people favor higher interest rates because the more interest they receive, the more money they have to spend. Many have found the interest rates of the last few years difficult. It has caused them to reduce their spending. It takes a lot more than a 10 or 15 percent cut in your tax rate to make up for a 50 percent cut in your income.
American populism has always held that our economy can either favor a narrow group of lenders or a broad group of borrowers. In fact, the rise of 401(k), 403(b), and other tax benefited savings plans has changed the balance. There may be only a narrow group of lenders with lots of money to lend, but you and I have a stake in lending these days, as well as borrowing.
And, trust me, higher interest rates won’t stop borrowers from borrowing. They’re tougher than that. What it may do is reduce the use of low-ball interest rates as a selling tool for houses and cars. That, in turn, might reduce the number of people who are painfully “upside down” on their consumer purchases. The change won’t be easy but it will lead to a stronger economy.
Second, higher interest rates will strengthen the dollar. With governments all around the world printing money willy-nilly one of the only ways to get foreigners to favor our particular currency is to pay interest on it. Otherwise its just bales of stuff too small to use as decorative wall paper. One direct impact of a stronger dollar will be less inflation: the cost of what we import won’t rise as fast and the cost of oil, the feedstock material for industrial economies, won’t rise as fast. Remember, while you and I have been struggling with higher energy prices for home heating, air conditioning, and driving, all of Europe has been enjoying lower prices.
Third, higher interest rates will increase our incentive to save. That is what we must do if we are to finance both the war on terror and prepare for our retirements. There is something about a 1 percent interest rate that makes you think, “Why bother?” about saving. When was the last time you saw a bank CD advertisement telling you how vast a sum you would accumulate with a $2,000 annual contribution to an IRA? (Hint: the answer is related to interest rates.)
Higher domestic saving is what we need to prevent our country from become the Blanche DuBois of the industrial world—depending, like Tennessee Williams famous ill-fated character, on “the kindness of strangers.”
This information is distributed for education purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, product, or service.
(c) A. M. Universal, 2004