Artificially Low Interest Rates? So what?

The Federal Reserve has held interest rates artificially low for decades. Even after pushing rates to zero in the wake of the 2008 financial crisis, “normalization” only managed to raise rates to 2.5% — hardly “normal.”  The central bank began cutting rates in 2019, even before the coronavirus pandemic.

But what difference does it make? Why do artificially low interest rates matter? Peter Schiff explains in this clip from his podcast.

In the first place, artificially low interest rates screw up the way the economy allocates resources and production.

The interest rate is the price of money. Prices send signals in an economy. Think of them as street signs. In a free economy, low interest rates would come about through an abundance of savings.

And if you have a lot of savings, what does that mean?

That means that people are not consuming today. Their time preference for consumption is in the future. And so the signal that sends to the economy is, hey, you don’t need to produce a lot of stuff for today because Americans are saving. They’re not spending a lot of money. So, you can invest in these long-term projects that aren’t going to pay off for years and years and years. And so then you end up investing in those types of projects that don’t have immediate returns because you got these low interest rates that are sending the signal that Americans don’t need the money right now. They’re going to save and they’re going to spend the money in the future.”

But in today’s economy, that’s not why interest rates are low. The only reason interest rates are at zero is because the Fed is artificially suppressing them.

Americans are still spending money like drunken sailors. Not that I want to insult the drunken sailors. But that means these are all malinvestments. And ultimately they’re going to have to be liquidated when the truth is unveiled — when interest rates eventually explode or the dollar implodes as a result of this policy.”

So, what would happen if the Fed allowed interest rates to rise to their natural levels — given Americans’ lack of savings and their propensity to consume right now?

All of the over-leveraged, money-losing, overvalued companies out there would not be able to get any capital.

They would all go out of business. The only companies that could get capital would be those who are putting it to productive use right now because they would have to pay these higher rates of interest, and they would have to be able to do that out of current cash flow. And how would they generate the cash flow in order to pay the higher interest? They would be producing the goods and services that Americans demand now — that they want to buy now. And in so doing, they would be able to afford this higher hurdle rate. They could pay the higher interest rates.”

These speculative companies promising earnings decades from now would not be able to compete with real businesses generating earnings today. Peter said those are the businesses that need the capital because we don’t have enough production. That’s evidenced by the massive trade deficits.

We need to invest more in productive capacity. But the Fed is preventing that from happening with its inflationary monetary policies. So, we’ve created this service sector, just-in-time economy. No one’s producing. No one’s got inventory. We’re printing all this money. And now, all hell’s about to break loose in this inflationary supercycle where these chickens are going to come home to roost — where we’ve got all this money and nothing to buy.”