America's Low Interest Rates Have a High Hidden Price Interest rates are the price of money, and though that price is near zero right now, the cost of low interest rates to our society as a whole may be getting too high.

It's widely accepted that such low interest rates are the only way to revive a struggling economy. But what if those widely accepted views are wrong? What if ultra-low interest rates have unintended consequences that outweigh their benefits?

If the popular wisdom were right, the economy would have revived by now. In the meantime, the cost of extremely low interest rates is that savers are watching their money lose value relative to rising prices.

So if low interest rates aren't the answer to reviving the economy and keeping it out of a deflationary spiral, what is? An alternative might be to create U.S. government securities linked to growth in emerging markets.

Near-zero interest rates have been the bedrock of U.S. economic policy for the last two years. During that time, economic growth has improved from minus 6.1% in the first quarter of 2009 to 2.5% in the third quarter of 2010. Meanwhile, corporations have loaded up on cash. They've stored up $1.84 trillion worth, and corporate profits are on-track to hit a record $1.66 trillion in 2010. But unemployment has remained high, and today sits at 9.8%.

Who Gets the Short End of the Low Interest Rate Stick?

Now, The Wall Street Journal is trying to make us feel sorry for the poor banks and others who are suffering due to the low interest rates. Its litany of low interest rate woes include:
  • Low bank spreads. The net interest margins for banks -- that is, the difference between what they pay depositors and what they earn on their loans and other assets -- fell from 3.85% in the first quarter of 2010 to 3.74% in the second quarter, according to the FDIC. This means that banks have to rely more on revenue from services unrelated to the spread in order to meet their profit targets.
  • Squeezed seniors. Seniors who rely on social security and bank account savings are suffering thanks to the 0.7% yields on bank accounts and the 10% to 40% increase in premiums for long-term care policies to cover nursing home expenses. Their costs are rising faster than their incomes.
  • Scrambling pension funds. Low interest rates are making it difficult for pension funds to make up for the losses they took during the financial crisis. These funds have moved money into bonds that pay yields in the 3% to 4% range -- far short of their 8% targets. But they are afraid that interest rates will rise which would decimate the value of the bonds since bond prices go down when interest rates go up.
I have some sympathy for this argument. To it, I would add that low interest rates are clearly contributing to the emergence of a new bubble based on bonds and commodity prices. For example, with gold prices near $1,400 an ounce after rising 26% in 2010, I found it quite interesting to hear a gold fund manager interviewed Wednesday on CNBC say that he thinks gold prices do not have much further to rise, and that when the gold bubble bursts, he will shut down his funds.

And since bursting bubbles always cause massive shocks to our economic system -- the bursting of the housing bubble, for instance, has destroyed $9 trillion in value since 2006, according to Zillow -- I would like to see a new system put in place to break our dependence on cycles of loose and tight money.

Go Where the Real Growth Is: Emerging Markets


One way to do this would be to link U.S. monetary policy to the growth in countries where capital is flowing. For example, according to the Institute of International Finance, emerging markets are expected to register a total of $825 billion in capital inflows in 2010, up 42% from 2009.

You might think that we should just worry about money flows within the U.S., but the simple fact is that our nation is part of a global system. The recent report on payouts from the $3.3 trillion program of emergency aid during the financial crisis reveals that billions in U.S. money went to non-U.S. banks, as well as to U.S. companies that do business globally.

Based on a May presentation I gave to pension fund managers on the Capital Receptivity Index (CRI) -- described in my book, Capital Rising: How Global Capital Flows Are Changing Business Systems All Over the World, which I co-authored with Srini Rangan -- there is wide interest in the question of how to analyze the risks and growth opportunities in emerging markets.

The CRI lets investors analyze how receptive emerging markets are to foreign capital flows. It scores each country on a scale of 0% to 100%, based on specific measures of its capital markets, corporate governance, human capital and intellectual property protection. And the CRI offers a valuable road map for investors to a fast-growing emerging market's risks and opportunities.

Using the CRI, the Fed might be able to create baskets of securities that could take advantage of the growth in emerging markets while shunning their risks. These securities would offer higher returns to banks, pension funds, and the average investor. And those higher returns would be backed by real economic growth instead of temporary bubbles.

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11 Comments

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vcgh2000

I always thought that interest rates are the cost of borrowing money.....not the price of money............Principal + Interest would equal cost.

December 13 2010 at 8:37 PM Report abuse rate up rate down Reply
scottee

duh! we should be a country of savers...and we need manufacturing jobs...not government jobs and not service jobs....we need smaller government and fewer taxes and free markets...and then maybe the jobs will come.

December 09 2010 at 4:42 PM Report abuse +1 rate up rate down Reply
jphilip

Very cogent point about pensions, especially in light of the imprtance of demography and the unsustainable stress on those financial vehicles as it is. Most defined benefit pensions are promises we cannot keep. Low rates are fine, but they do add to the pension issues.

December 09 2010 at 3:19 PM Report abuse rate up rate down Reply
Gumby

do not start spouting off some bullsnot about how much electricity it requires to make new aluminium.. I KNOW THIS ALREADY AND IT DOESNT MAKE NO DIFFERENCE ONCE YOU LEARN ALL YOU CAN AT WWW.ALCOA.COM .. GO THERE NOW AT ONCE!!!!!!!!!!!!!!!!!! DISMISSED!!

December 09 2010 at 2:45 PM Report abuse rate up rate down Reply
Gumby

Every one of YOU ought to go to WWW.ALCOA.COM to learn all you can about the old BORING ALUMINIUM!! It is gonna be worth your time doing so!! I am telling y' all! ALCOA IS WORKING OVERTIME TO SAVE EVERY DROP OF OIL THAT YOU WASTE!!! EVERYDAY!!!!!!!!!!!!!! at $1 A POUND FOR ALUMINIUM.. THIS IS THANKLESS SLAVERY PRICE!!

December 09 2010 at 2:44 PM Report abuse rate up rate down Reply
pacillivil1

at some piont the piper has to be paid. lets set new interest rates. say 5% on housing, 5% on credit cards , 5% on bank deposits , 5% on everything. then let the market find it's own level. then let's set the tax rate at let's say 5% . what this would would give everyone a constant. lets try it for say 5 years and if it doesn't work we can go back to the old system. lets put into place a law that says govt and congress can not spend more than the recieve. the country will fix itself in 1 year. sounds to simple right . well it is . think about it .5% in 5% out . what a deal

December 09 2010 at 2:26 PM Report abuse rate up rate down Reply
Gumby

Automotive engines are made of aluminium now! We thought we couldnt but we can today. So is wheels. We are busy replacing aluminium windows with cheaper vinyl to help stretch aluminium supplies.. Actually, aluminium consumption is growing rapidly, yet producers keep on building more smelters faster. Something is really going on.. One day, prices will zoom, that is for sure!

December 09 2010 at 2:07 PM Report abuse rate up rate down Reply
Gumby

I mean, why is aluminium still so cheap?? It is a critical metal to the world economy and producers are basically giving it away at just $1 a pound!!

December 09 2010 at 2:05 PM Report abuse rate up rate down Reply
Gumby

Can you please explain why we are not speculating on aluminium yet??

December 09 2010 at 2:03 PM Report abuse rate up rate down Reply
bfpowersjr

Mr. Cohan: Excellent article.

December 09 2010 at 12:32 PM Report abuse -1 rate up rate down Reply