Interest Rates: Because We've Always Done It That Way

Interest Rates: Because We've Always Done It That Way

Introduction

There are a great many people who seem to want to believe in higher interest rates. That they're "Better," perhaps "Normal," or "Ideal."

There's this thought about what a normal rate should be. A normal that dates back to a time of kings and queens. A time of colonization. Times of sustained poverty & class systems. I want to deconstruct some traditional thinking about interest rates. Feel free to disagree with my opinions but hopefully some of the ideas prove useful. Bare in mind that what I'm going to be saying is the opposite from what many will want to hear.

Many people would say that the normal rate (when I say rate read risk free interest rate such as that set by the federal reserve) should be something like 4%. The argument will normally read something like, "because that's roughly where it is most of the time" or, "there needs to be a cost of capital to not misallocate capital to wasteful spending."

The Message

I'll address both of those but first I want to look at what a 4% interest rate says. Saying a higher interest rate is good is somewhere between the money equivalent of "Yes I know where electricity comes from, there's a plug right over there," &, "Wouldn't the world be perfect if I was the emperor." Where does the money come from that pays those high interest rates? And... Good for who? Suggesting that an ideal interest rate is 2% above an ideal inflation rate is to suggest that having capital gives people the right to tax society. 

Maybe you believe that, maybe you don't. Maybe you think, well, in order to get this capital I had to pay taxes so I deserve it. I don't know what you think. I don't think my one line was a deep enough summary. It's a tax for two reasons. Firstly; in the current setup of the US for example, the $35 trillion in government debt is the biggest payer of interest in the economy. That is literally (un)-funded by the taxpayer. All else equal, higher rates should mean higher taxes.

Secondly; moving interest rates higher raises the cost of money to every company. The companies who do things like... Build homes, make food, etc. This increased cost of capital either reduces their investment or causes them to push their costs on consumers. Consumers then have to pay more to buy food, cars to get to work, and a house to have a family etc. Everyone must pay their added fees... Because for some people's 'ideal' people with money DESERVE to be given more money. Is that capitalist or feudal?

Higher investment hurdles & more money spent on servicing the borrowed capital... Wouldn't it be funny if the Bank of Canada hiked rates up 500 basis points in a few years then 'sounded the alarm on productivity?' How is it possible that the the productive paying more interest to the unproductive hurts productivity? We probably need more academic papers on the nuisance of what constitutes productivity for us common folk to understand.

Does it surprise you that people with money and influence would prefer a world where having money means you have a societal right to have more for free? Before I inspire some socialist, I want to point out a distinction here. Capital, invested in a business or asset creates jobs, increases productivity, lowers costs for consumers, generates taxes and overall benefits society. Business investment makes everyone's lives better... But it also carries risk. The business could be replaced by another better business. It could lose money. Paying more money to a credit risk free, overnight lending is the reverse. It's a drain on capitalism... So when you see one of those loons who's calling for +10% real rates because that's capitalism, you're seeing someone who believes they should be treated like a king because they, or their family have money. It's not a functional system, it's an individualistic ideal.

The misconception around interest rates is an entrenched problem. It's a generational issue. Older people are perfectly happy clipping their 5% coupon easing into retirement. Quick to tell the younger generation how much they paid back in their day.

Younger people then are stuck paying the tab from the higher government debt and now having to fund their parents retirement & pay more than necessary for their house... While ironically having to deal with "where are my /why not more grandchildren?"

I started this by talking about kings, queens, and classes for a reason. "Because we have always done it that way," doesn't make it inherently right. People love saying that low interest rates cause wealth division. That's not logical nor is it a full story. If you look at the very wealthy, many are those who created businesses that millions use and benefit from. Amazon, Microsoft and so on. If low rates allowed businesses and people to thrive, that would also cause capital to pool up in the hands of good businesses and their owners. Saying that's bad is in interesting superficial argument that amounts to, "Wouldn't it be better if less people could buy Iphones and shop on Amazon." I don't know about better, but there'd be less wealth inequality and if that's the only measure of better then maybe we should revert to Stalin's USSR. Thinking logically about the rich-poor dynamic, it SHOULD becomes more difficult to argue that those without money giving more money to those with money, is good for those without money... Incredibly, the most common arguments amount to, the poor need to be poorer to help the poor. It's a hidden way of enforcing a neo-class system.

Wasteful Spending 

I can understand not wanting money to be thrown around too liberally when there's an inflation problem. (Now, how the Government throwing around an extra 2% of GDP in deficit spending on interest payments is helpful to cool inflation has yet to be adequately explained to me)… Wasteful spending is a judgement call. Controlling how others waste their money is an interesting question. Should we let people buy products that will slowly kill them and be a tax on the medical infrastructure but not burn their money on a business that sells snowmen online? In the end, if the spending is wasteful, it will be replaced by something else. Maybe it's a stupid idea... It probably is (whatever you're currently imagining).

I should also point out that there have been many times where people threw money at wasteful, stupid ideas outside of a low rate environment. If you can't find any right now with rates at 5%, perhaps you might in Y2K? 2007? Stupid things will happen in every environment. It's what unites us as humans.

My Opinion

My belief would be that right would be either 2% or 0%.

2% because I could argue that it would be good for people to have a way of safely maintaining their purchasing power. I recognize there are plenty of other ways to almost do this and perhaps those should be good enough but as a baseline lowest possible risk, not losing to inflation seems reasonable.

If I was more of a capitalist, I'd say ideal is 0%. If you want returns, put it somewhere helpful to society... Or pay your tax (inflation) for the safety. If money is "too cheap" borrow it and put it to a good use... (You'd quickly find out that 0% interest on government bonds doesn't mean free money). Most of the "0% rates caused problems" arguments aren't as logically sound as they purport to be. They're often significantly based in nostalgia & bias. If it pushed prices too high, why didn't more supply come... For instance.

I don't think it makes sense to subsidize the unproductive by taxing the productive. Nor does it make sense to put added financial strain on people in their 20s-40s only to come back with... Gee... why is the birth rate declining? Remember, the risk free overnight rate isn't the price for all money. It's the basis upon which the rest of the money is priced. Most items are set by the market. Fed funds isn't whether too high or too low, that's one number that is completely manipulated. It gets chosen and the rest of the prices follow. Let's not conflate private entities mispricing credit risk with something that's caused by one overnight rate or another.

Nobody forces anyone to lend money to anyone else*. 2% for the government might mean 5% for an enterprising business and 10% for someone with poor credit who needs a used car to commute to work. The idea of "Easy Money," is relative. To the rich, +5% interest rates is precisely "Easy money," in a different way of course.

Does any of this matter?

Ideal doesn't matter at all IF interest rates were merely set as a scientific policy to control inflation. That's mostly a separate discussion. A discussion which I think conventional thinking is equally misguided about, once again ignoring half the equation.

There are also a bunch of people who think they read a textbook that says something along the lines of 'high interest rates are good because they mean there's a lot of demand for money to invest.' A theory akin to, "With interest rates high there's nobody why wants to fund the US government because it can't afford the higher interest rates." Aka, a story that people tell because it sounds like it makes sense despite it being evidence-less, reflexive and an arbitrary price driven narrative. It's overly simplistic so people take it as fact instead of delve into an evidence driven debate around multiple factors and theoreticals.

That's enough prognostication for one day. Thanks for reading.