Interest Rates And Failed Monetary Policy
How often have you heard about the Fed (or any central bank) to stimulate or cool the economy? How often has it worked?
This is something that is rather obvious when we understand what things are for.
Monetary policy Fails Because Interest Rates Aren't Stimulus
In an era where people were reared on the mythology of central bank power, people are led to believe stuff that isnt true. It is also why we find the Fed implementing monetary policy that repeatedly fails. If they are so smart, how come they have to keep developing more tools to combat things, especially when they tell us they have enough?
The answer comes from the fact this is all propaganda. None of what they do work because, quite simply, the Fed doesn't do money. They are not in that business so to believe they can directly inject anything into the economy is a misnomer.
To understand why this is, let's start with the basic structure?
Do you know why there are 12 regional Federal Banks? What is the purpose of having them?
The answer lies in interest rates. What was originally designed, before FDR destroyed it, was a system whereby the different regions controlled their interest rates. The reason for this was to prevent crashes like happen in the early 1900s.
Each regional bank was free to raise or lower interest rates as they saw fit. They did not do this to stimulate the economy. Instead, it dealt with the thing that capital does impact: capital flow.
If a region found its banks did not have enough capital, facing a run on banks, then it could raise interest rates to attract capital from different parts of the country. Money moves where it receives the best return. This is what kicked off the Eurodollar system as Midland Bank started offering USD deposits better returns than they could get in the US.
Of course, if a region was flush with money, then interest rates could be lowered to drive capital out, knowing it would find a better home.
Keep in mind, this is bank driven decision.
Also notice how none of this deals with the impact upon the economy.
A Bank's Product
There is also the market factor to consider.
To explain that, we have to look at what a bank sells? What is the product a bank puts onto the market?
The answer is simply money. Banks are in the business of "selling" money. That is the product. Of course, like any business, these institutions want to make as much money as they can. In other words, they want to get the most out of each sale.
We come to know this as the interest rate.
So why don't banks simply lend at higher rates?
This comes down to a supply and demand equation. If there is a high demand for money, like any product, the price is going to be higher. The reverse is also true.
Hence, when things are going well, banks can charge higher rates with there is a supply of qualified borrowers. Part of the process is accessing risk, i.e. the likelihood of getting paid back. When the borrowers who are likely to fall into that category are in short supply, the demand is depressed.
This is why interest rates fall.
It is also the exact opposite of what people are taught. Banks and central banks are on opposite sides of the equation. When the economy requires stimulus, this is the exact time that commercial banks back away. Here is where the central bank is impotent. It cannot force the banks to lend.
Most look at interest rates from the borrowers perspective. The idea is lower interest rates will cause more borrowing. That is wrong. It is only the case for dumb money.
Do you know who isn't likely to borrow from a bank in a low interest rate environment? CFOs. These are the people who sign off on $25M or $50M loans for new plants. Do you think they are going to borrow when the economy is crappy? No.
Ergo, we see the list of qualified buyers drying up. From the banks perspective, there is not the incentive to lend. The ones who want money are not of the quality these institutions are seeking. Therefore, they start to raise their lending standards and cut credit limits as things start to head south.
The Fed and every other central bank has to fight this. Unfortunately, since they do not do money, they are powerless to inject anything into the economy. The money supply is basically in control of the commercial banks and they are not going to lend when things are getting riskier, especially if rates are dropping meaning they get paid less to take on more risk.
This is not how bankers operate. They are the ones who do and know money.
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The traditional banking system has lots of flops. Only a pity this always bites back on the financial strength of the citizens when looking at the area of inflation. The monetary system needs a reshuffling. Are they on the other hand ready to listen.
You mentioned CFOs not wanting to borrow in a low interest environment. How about smaller businesses, and maybe regular families?
If you are at risk of losing your job, do you go and add more debt to your balance sheet? Dumb people do but the smarter ones tend to consolidate, increase their savings, pay things off. Same with small businesses. A restaurant owner tends not to want to add a second location during a recession.
Besides, the banks tend to get tighter with their lending which limits what those people can do anyway. Small businesses havent had access to credit in half a decade (at least). That is the fallacy of low interest rates meaning easy money. It means cheap money.
Nothing easy about it if you are a small business. Yeah Apple can head to the bond market and get $50 billion cheap but a restaurant owner is screwed.
I'm not talking about the extremes. People aren't just divided into the rich and those at risk of losing their job. There are a lot of people in stable jobs, that can look to these lower interest rates as a sign that they can try buying a new car, or a new house. My sister bought a house during the pandemic.
There is nothing extreme about it.
You have a large section of the population in the developed countries that are really living paycheck to paycheck. Hence the idea of a stable job is really misleading. There are a "lot more" who arent. Are coders stable? Seems the tech sector has been cleaning house. The automotive industry is in recession. Retail is always crap. Automation is gaining favor with companies that can afford to implement it.
And people believe interest rates are going to remain elevated. These are deflationary scenarios which always impact the working class the most.
Again, banks are going to tighten lending during those times.
What you are describing is what Milton Friedman talked about with the interest rate fallacy. Yet, 60 years later, people are still believing lower rates means money is plentiful when it is the exact opposite.
I was mostly talking about the middle to upper middle class. A lot in the medical field have relatively stable jobs; Physical Therapists, Nurses, Doctors, etc. I do agree that a lot more in the tech industry are getting hit because of the generative AI. But DBA, Sysad, Network Engineers, Server Engineers, Audit, etc, are stilly relatively safe. There are definitely starting to be more automation, but with critical systems, humans are still dominant.
I think people in those kinds of jobs with relative job security are the ones who can take advantage of lower interest rates to buy big ticket items. While they may not be as much as those whose jobs are in jeopardy, I think it does help get some money circulating.