BLOG: Nothing is Free

Don outlines the recent actions of the Federal Reserve, and the winners and losers as a result of its policies.

The function and purpose of the Federal Reserve is not widely understood, but most people know that it regulates interest rates.   They also know that "The Fed" has been driving interest rates down to historic lows in the last few years.

The purpose of its action is to "stimulate" the economy.  It is easy to find news articles about how "The Fed" is planning on maintaining this "easy money" policy until the economy "recovers". (also here)  The theory is that if businesses can get money cheaply, they will investi it, and grow their businesses.

The result of this policy is that interest rates are at historic lows.  The rate on a 10-year T-bill is currently 1.62%, less than half the historic average.  This is great for those who want to borrow money, but not good at all for those who have savings and need the interest income.

Retirees have been severely squeezed by this, because conventional wisdom guides retirees to keep most of their money in bonds.  Planning for retirement was probably done with yields on those bond funds in in the 4-5% range. When bonds are trading at sub-2% interest rates, those plans are ruined.

Another effect of the "easy money" policy is that as a large corporation, you are able to borrow money at next to no cost.  Smaller companies cannot do this, because the overhead and risk involved in loaning to them is larger, relative to the size of the loan.  The big beneficiaries of this policy are companies like Amazon.com and Google.  (Read here)

In an ironic twist, easy money also burdens our young people.  Encouraging borrowing encourages debt.  Case in point, state and federal governments borrowing like mad because it's so cheap.  The losers?  Our young people, who will be stuck with the bill.

In any economic policy, there tend to be winners and losers.  There may be lots of disagreement on any given policy both about who these winners and losers are, but about who they should be.  In this case though, the winners are clear - big companies, big banks, and politicians.  The losers are clear as well - retirees, savers, and the young.

This post is contributed by a community member. The views expressed in this blog are those of the author and do not necessarily reflect those of Patch Media Corporation. Everyone is welcome to submit a post to Patch. If you'd like to post a blog, go here to get started.

Timothy November 29, 2012 at 03:50 PM
I think you're over-simplifying here. In the short term, monetary easing pushes down interest rates and monetary tightening pushes interest rates up. But over longer-term horizons, the opposite is true. To see this, you just have to compare the late 1970s to the early 1930s. Interest rates were extremely high in the 1970s. They were extremely low in the 1930s. Yet the 1970s were clearly a "loose money" era, while the early 1930s were a time of unusually tight monetary policy. The reason is that long-term interest rates are driven by both supply and demand for credit. The supply comes largely from the federal reserve, which is why printing money pushes down interest rates in the short term. But the demand comes from peoples' expectations of future income growth. If businesses expect the economy to be growing briskly between now and 2020, they're going to be more interested in borrowing and investing today to take advantage of that higher demand in future years. In contrast, if businesses expect the economy to continue stagnating, they're going to be less interested in borrowing money, which will lead to lower interest rates. You can see this effect at work in Japan. Nominal interest rates in Japan have been close to zero for most of the last two decades. Yet it's hard to describe Japanese monetary policy as particularly loose. The net inflation rate has been around 0 over the period. The low rates there are a sign of tight, not loose, money.
Timothy November 29, 2012 at 04:14 PM
To provide some empirical backup for my previous comment, take a look at interest rates on long-maturity treasury bonds over the last 5 years. You'll see the response to QE announcements are roughly the opposite of the effect you assume in your post: http://seekingalpha.com/article/872281-the-biggest-misperception-about-qe Interest rates on 10-year treasuries have tended to rise when the Fed is expanding its balance sheet. They tend to fall when QE rounds expire. The reason, I think, is that monetary easing not only affects the supply of credit, it also affects the market's expectations about future nominal income growth. Businesses expect monetary easing to increase economic activity, which will mean more potential income for them in the future. And that makes them more interested in borrowing in hopes of capturing a larger slice of the growing pie. The movement of long-term interest rates provide circumstantial evidence that, at least in the relatively tight-money environment of the last four years, the interest-rate-increasing effect on expectations is more significant than the direct rate-reducing impact of the Fed's bond purchases.
Donald Lee November 29, 2012 at 06:11 PM
My point is as simple as I could make it. I am trying to make the simple, obvious, and I think unassailable statement that when interest rates are low, borrowers win, and lenders lose. I then point out some of the people in those classes. Winners are not necessarily the mom and pop grocery stores, and the losers include retirees, who are being being severely squeezed by the loss of income from low interest rates. Pension funds are in a similar bind, with investment yields far below what they need to fund payouts to existing retirees. Whether or not QE (http://en.wikipedia.org/wiki/Quantitative_easing) is causing the lower interest rates is also beside the point. The Fed is explicit about lower interest rates being one of their goals. I am only discussing the results on the ground of having accomplished the goal. Second and third order effects, and the supposed connections between interest rates and what people call "loose" and "tight" money, and how and why those conditions may or may not affect overall prosperity are very interesting, but are far beyond the scope of my remarks. Thank you for posting.
Timothy November 29, 2012 at 07:20 PM
I agree with you that low interest rates are bad for savers. What I was disagreeing with was the assumption, reflected multiple times in your post, that "low interest rates" and "easy money" are equivalent concepts. The world is more complicated than that. Tight monetary policy can produce low interest rates if it leads to a collapse in demand for credit, as I believe may have happened during the present crisis. So you can't necessarily assume that low interest rates are the result of easy monetary policy.
Timothy November 29, 2012 at 07:32 PM
One other point: I think it's important to distinguish between short-term and long-term interest rates. Obviously, a more accomodative monetary policy means lower short-term interest rates in the short term. However, I think it would likely raise long-term interest rates, as private firms increase their borrowing in anticipation of rising aggregate demand. And long-term rates are what matters most for pension funds and people saving for retirement.
Donald Lee November 29, 2012 at 10:28 PM
My neighbor was complaining to me recently that his income is down, and his savings are being eaten up much more rapidly than he planned. He's worried that he may outlive his savings. I doubt it is comfort to him that long term interest rates should be higher. I doubt the union pension fund(s) that have the same problem, and asking for raised dues to cover the shortfalls would be comforted. Perhaps they are using the wrong investment strategy? The term "easy money" is a simple, widely understood handle. I'm open to using a better term as long as it does not require sorting through all the shades of policy nuance and code-speak that often comes from the Fed. The term is a crude shorthand to describe what the Fed explicitly intended to do. (and succeeded, whether coincidence or cause) http://www.theatlanticwire.com/business/2012/06/fed-expands-its-fight-lower-long-term-interest-rates/53746/
Timothy November 30, 2012 at 12:12 AM
I don't understand what you mean when you say "I doubt it is comfort to him that long term interest rates should be higher." If long-term interest rates (by which I mean the interest rates on long-maturity bonds) were higher, then couldn't he invest in long-term bonds to get a higher rate of return? And wouldn't that solve his problem?
Donald Lee November 30, 2012 at 05:36 AM
If it were that easy, the bond funds managing his retirement would do it. Current rates on 10 year bonds are 1.62%. On 30 year T-bills it's around 3%. 30 years is a long time to have to lock up your money to get a rate that is close to half the historical average.
Timothy November 30, 2012 at 03:39 PM
After re-reading the above discussion, I've concluded that there are fairly deep differences in our respective theoretical models of how monetary economics works. And it's probably not practical to adequately explore those differences in 1500-character chunks. It's a complex and sometimes counter-intuitive subject. I'd love to discuss the subject in person some time.
Ken in MN December 04, 2012 at 01:02 PM
Timothy is correct: Long-term interest rates are set by the market, and the market has concluded that the Republican't stranglehold on fiscal policy is choking off the prospects of economic growth anytime soon. Thirty years of working class wage stagnation thanks to the policies of Reagan/Bush/Shrub hasn't helped, nor has Blue Dog/Wall Street Democrats buying into the economic fantasies of Supply Side "Economics". You can't dispute that the US economy grew fastest when top marginal income tax rates were high, when capital gains were taxed the same as income, when unions were strong, and people could live a decent life after retirement thanks to defined-benefit pension plans supplemented with Social Security and Medicare (while spending trillions of dollars into the consumer economy.) That said, Donald is correct when he says nothing is free. The Plutocrats can't expect economic growth (of even the continuation of a stable society) if they expect their workers to work for free...
Donald Lee December 04, 2012 at 03:59 PM
The point of my post is to highlight the winners and losers in a low-interest-rate environment. The big winners are often not the mom-and-pop small businesses, but big players, like Google. Big losers include retirees. The Fed has been explicit that it's policy is to drive down interest rates. Operation "twist" was specifically aimed at reducing medium term interest rates. Interest rates are now low. Whether and how the Fed influenced this is an interesting topic, but not the one I intended to discuss here.
Ken in MN December 05, 2012 at 01:18 PM
Then why the slam on union pension funds? They, like every other pension and 401k fund are invested in the stock and bond markets, and they, like every other pension and 401k fund, felt the effects of the Reagan/Bush/Shrub economic meltdown, and they, like every other pension and 401k fund, will recover when the economy recovers. In addition, union pension fund contributions are set by contract. They just don't demand more money and get it! Try educating yourself on union pension funds. Here's a good first step: http://www.startribune.com/blogs/141614483.html
Donald Lee December 05, 2012 at 06:35 PM
I apologize if I am unclear. This post is not intended to be politically inspired. It is not a commentary on the complexities of the Federal Reserve and its policies. There are no "slams" on anyone. It can be summarized like this: We have a low interest rate environment. The actual winners and losers in this environment are not those we expect. The winners include large firms like Google and Amazon. The losers include those depending on interest income, like retirees. This is a simple, factual message. I am frankly surprised that those commenting insist on seeing everything BUT the point.
Ken in MN December 06, 2012 at 01:45 PM
OMG! Low interest rates are "crushing retirees", as the TIME Magazine said. Too bad it's more anecdotal hype than reality: http://articles.businessinsider.com/2012-02-01/news/31011704_1_low-interest-rates-bernanke-pension-funds Of course, by looking at actual data, instead of relying on anecdotal neighborhood conversations or "gee, everybody knows that" thinking, we find that investment income only accounts for 11% of all income reported by seniors in 2009. The largest sources, by far, are Social Security (38%), earnings from active employment (29%), and pension plans (19%). http://www.aoa.gov/aoaroot/aging_statistics/Profile/2011/docs/2011profile.pdf (And yes, I looked back at reports from before the Bush Great Recession and found it was only 13% in 2005 vs. 11% in 2009 http://www.agingcarefl.org/aging/AOA-2007profile.pdf) So the benefits to the "winners" of low interest rates (like taxpayers servicing the Reagan/Bush/Shrub Federal debt, homeowners, businesses seeking to expand, car buyers, students borrowing for college) far outweigh the over-hyped harm to the "losers" of low interest rates.


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