Fixing America’s Economy

There are numerous Economic truths. One of these is that, in a Free Market, interest rates are set by borrowers and lenders based on each group’s perceptions of the urgency of their need to take action.

A borrower may have a business opportunity which will yield an expected profit. If it is a longer term project, such as building a new factory, the cost of money may need to be in a relatively narrow band to make the plan feasible. A shorter term project horizon, such as a 6 month loan to finish off 20 new homes, which are almost completed, might withstand a much higher interest rate. The “combined” need for money for these projects will constitute the demand for loans.

A lender may have numerous uses calling for his money. The interest rate he can get offsets both his deferred spending of the money and the risk that the money won’t be paid back.

A loan only happens when both a borrower and a lender benefit from the trade – in this case it’s a trade of the use of the capital. The interest rate needed to satisfy both a borrower and a lender is not set in stone – it can change daily or even more quickly. But, whatever the interest rate set that moment, it best serves the largest number of borrowers and lenders.

For 100+ years, since the creation of the US Federal Reserve (FED), and also during previous US paper money regimes (eg. 1^st & 2^nd National Banks, the Continental currency, and the Greenback), our government has interfered with the Free Market setting of interest rates. Because this interference set the interest rate at a level different from what a Free Market would have created, some borrowers or lenders had to settle for less than the best deal for all concerned. As an Economy, all Americans suffered – we all became poorer because of the government interventions.

It matters not at all whether the interference was due to stupidity, arrogance, or just simple corruption on the part of the government officials, or whether their motives were benevolent or malevolent. Their constant screwing with the Free Market has hurt all Americans, although a favored few did benefit along the way.

A second truth in Economics is that these government interventions are not sustainable. The degree of distortion will vary with both the degree and duration of the government’s manipulations, but eventually, the government MUST reverse course.

Here in the US, our Central Bank, the FED, has kept the short term interest rate pegged to zero for almost 7 years! Zero compared to a more normal 4-5% is a big deal. And, the FED has been doing this for an astounding 7 years! That’s another big deal. They have managed this feat by creating Dollars out of thin air – electronically – multiplying their balance sheet almost 6 times.

Current FED Chief, Janet Yellen, inherited this mess from Bernanke (with a start by Greenspan). While she is no Free Market champion (quite the opposite), she realizes that all hell is about to break loose. Unemployment (ignoring the cooked stats) is around Great Depression levels, with bread lines in the form of 50 million Americans on Food Stamps. GDP (again ignoring the cooked stats) has been contracting in real terms for a dozen years, and even those bogus numbers show the US sliding into another Recession. There’s more bad news, but you get the idea.

Janet Yellen has been floating the idea of raising rates, and the markets and big financial players are scared out of their wits. Rate hikes seem off the table for 2015, and a QE4 is becoming more of a possibility.

But, no matter what the FED does going forward – regular rate hikes, a “one-and-done” increase, or continued insane interest rate suppression – bad stuff in the US Economy is coming. The FED’s previous manipulations are the primary cause, and FED actions near term can act only to make the coming pain either short and horrific or moderate and drawn out.

Before getting to what I would do, I’d briefly mention a couple of additional Economic truths.

• Government Spending, being funded by taking the money away from the Consumers, Employees, and Owners who earned it, is a net negative for the Economy. The individual programs can be merely bad or downright lousy for the Economy, but the total effect is a big negative.

• Government Regulation, acts similarly (but worse) than Government Spending. It too takes away value which otherwise would go to Consumers, Employees, and Owners. Government Regulation makes us poorer, even if most people are taught to look only at the occasional positive side, while ignoring the immense costs.

So now, what to do with our current lousy Economy and an interest rate suppression situation which MUST end.

Action Item: Allow interest rates to return to Free Market levels gradually, while drastically cutting both Government Spending and Regulation.

• Require the FED to raise interest rates gradually to Free Market levels, on a strict schedule that everybody will be told in advance. I suggest the following – While rates are:
  • Below 0.50%, allow rates to rise by 0.01% 1 day a week
  • Below 1.00%, allow rates to rise by 0.01% 2 days a week
  • Below 2.00%, allow rates to rise by 0.01% 3 days a week
  • 2.00% and up, allow rates to rise by 0.01% 4 days a week
• Cut Government Spending DRASTICALLY. The rate hikes, by removing the artificial low rate supports, will cause readjustments in our Economy, as a lot of dead wood projects are liquidated. By letting capital stay within the private, productive sector of the Economy, it will make the transition somewhat less painful.
• Cut Government Regulation DRASTICALLY. The positive effects on the Economy will be even stronger than just the spending cuts, and they will reduce the readjustment pain even further.

My schedule for normalizing interest rates will take several years, which may be too long. I prefer moderate pain for a long time, but I am open to other possibilities.

Please understand, there will be pain going forward no matter what we do. It can be great and short, or it can be less but long. It can help us to recover from all the previous stupidity, or it can prolong the disease and make the total pain worse.

This is not a Goldilocks world. This is a Command and Control Economy that we’ve been suffering through. We can rebuild slowly, a la the German Miracle after WWII, or we can continue bumping along as we did after the Great Depression. I choose the latter, which requires less government.