Friday, October 16, 2009

Near-Zero interest-rates are The Won’s drug of choice . . .

For the Benefit of Those Too Young to Know . . .

Normal people, in normal times, used to live on the interest from their savings.  No one can live on zero or near-zero interest rates.  Grandmothers and grandfathers used to live on interest, then they lived on reverse-mortgages and now they live on principle. 
You may think of that as your parents
consuming your inheritance.
The foreign exchange rates for the dollar are – in normal times - largely a reaction to the interest rate paid on dollar deposits.  As interest rates go up, foreign investors buy dollars to earn the higher interest. 
You may think of this as interest rates going up
and the price of BMW’s going down.
The Won’s stated reason for near-zero interest rates is to accelerate business expansion by making borrowing less expensive.
            But banks aren’t eager to lend at all in this business environment.
            But businesses aren’t eager to borrow when changes to tax and employment policies are discussed without assurances or time-tables.
            But banks are making a fortune borrowing at near-zero interest rates and charging the moon on credit card and other debt.  Yes, I know that their back rooms are stacked to ceiling with bad debts on credit card, residential and commercial mortgages.  How that will shake out is anyone’s guess since the banks have special relations with Washington.
            You may think of that as your classmates in banking pocketing bonuses through the meltdown
and having no idea when the party will end
 . . .but probably very soon
 unless Washington bails them out again
 . . .and that’s a not a bad bet.
Interest rates are the cost of money.  Just like the cost of oil or BMW’s or bloomers, interest rates – the cost of money - determines what is worth buying or not . . .or, in the case of money, worthy of investment or not . . .or, whether consumption is worth deferring for the sake of the interest earned.  When interest rates are near-zero, there is no point in deferring expenditures. 
You may think of this as the Federal Reserve 
(contradicting your parents’ advice) 
encouraging you to spend 
as though there were no tomorrow.
For business, near-zero interest rates (a figment of Washington speechifying, at the moment, since banks aren’t giving low-interest loans) make investment less expensive.  But investments must generate the income to pay back the borrowed funds.  The economy is now being controlled by imperial edict, rather than by market forces; in this environment, near-zero interest (almost-free money) does not fix anything.  At the moment,
No one knows how long interest rates will remain low;
No one knows when the economy will improve;
No one knows what tax rates will be;
No one knows what the dollar exchange-rate will be.
This all rolls into a ball where the risks are cannot be measured.  In this environment, businesses avoid risk.  Near-Zero interest rates accomplish nothing but give banks a temporary boost in earnings (and bonuses) until the bad loans become impossible to ignore.
You may think of this as

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