Since the collapse of the United States economy at the height of the Great Recession in 2007 and 2008, consumers and governments have given interest rates a bad reputation. Is it wrong to blame them?
The United States Government borrows nearly half of every dollar spent so just imagine the annual interest payments on the debt. Consumers, meanwhile, have to pay hundreds of dollars each month on their credit card debt. Again, one can’t really vilify both parties for being upset.
On the other hand, though, interest rates make the world go round. Lenders have to be given an incentive for lending money, whether it’s $100 or $100,000, to entrepreneurs, students and governments. Financial institutions, venture capitalists and payday loan establishments can’t just hand money out not expecting anything in return.
Without a certain amount of interest, small businesses would not be started, students would not go to a post-secondary institution and the examples go on.
Unfortunately, the Federal Reserve and central banks across the globe have hijacked interest rates and the supposed smartest men in the room have set the interest rates, money supply and other forms of monetary policy. However, it should be explained that no one knows what the correct interest rate or money supply should be. Who knows? The marketplace!
With that being said, central banks have implemented record-low (Japanese-style) interest rates that are encouraging consumers and governments to sacrifice the future for the present, spending money they don’t have instead of saving for the future. This is a harmful endeavor that will provide a long-term negative consequence for the national economy, wherever it may be.
Furthermore, producing artificial interest rates send wrong signals to the marketplace, much like what happened in the Great Depression. By having a manipulated interest rate, whether it’s high or low, can tell the consumer to spend or save, give the impression to businesses that they can invest or hold back or inform a legislative body that they can spend a lot of money or diminish they’re already bloated budgets.
Indeed, a central bank can in theory increase or decrease interest rates, that is until reality sets in, which is presently transpiring. Right now, all of the economic data and charts are suggesting that interest rates are climbing, which is bad news for governments and consumers, though the positive could be that politicians and households will begin to take action before the situation gets out of hand. Due to the track records of politicians, it seems doubtful that they’ll take the bold initiative necessary and reduce the budget, cut the debt and perhaps even pass a balanced budget amendment.
A new study found that Canadian consumers are spending vast amounts of money again and going into debt to buy things they don’t need (we never learn!) – it was reported that Canadian seniors are growing their debts at a faster rate than their younger counterparts. Meanwhile, Americans are cutting the amount they save so they can spend more. Both figures are extremely dangerous.
If consumers don’t start to get their personal finances under control they face paying astronomical interest payments each month. If governments don’t begin to become sane then they risk paying $1 trillion in debt interest payments each year. Years ago, David M. Walker, former U.S. comptroller general, warned that the debt could become so high that the U.S. government could only pay for some entitlement programs and the interest on the debt and nothing else.
“The most serious threat to the United States is not someone hiding in a cave in Afghanistan but our own fiscal irresponsibility,” said Walker in a bold statement in 2009.
Interest rates are important, but akin to other economic issues: the free market should be embraced and the market should be left alone.