How Low Interest Rates Are Tearing America Apart; 3 Steps You Can Take Today to Protect Yourself By Charles Delvalle
September 30, 2011
Note from Andrew Gordon: My talented analyst, Charles Delvalle, is right about the banks not lending. But I want to add two additional explanations! Reason number one: Cash-rich companies. Why would companies borrow when they're sitting on record amounts of cash? Reason number two: Both corporations and individuals are reducing debt, and saving up for "rainy days."
Dear Insider Fortunes Reader,
Were your parents like mine? Anytime I'd raid the snack counter, they would always tell me: "Too much of a good thing is bad."
Well, the same thing applies to low-interest rates.
During your average recession, lowering interest rates definitely helps stimulate the economy. But when interest rates get too low and stay there for too long, it actually turns into a bad thing.
The best way I can explain this is by showing you something called "price theory." It goes like this…
Let's say a place like New York deems that rents are too high for the average person. So it institutes a price cap on the amount a homeowner can rent his place out for. As a consequence, rents go down across New York, and people fill up all the available apartments.
At first, it'd be a good thing. People would have more money to spend on other things. But at some point, these price controls would actually allow demand to climb way above the available supply.
Now, New York would have a problem – they would have no vacant apartments to rent out. And as an apartment building owner, you would have a problem too. If you can't increase your rent, you lose your incentive to lease out at all. So you sell the apartments you own in New York and buy another apartment building somewhere else where there are no rent controls.
And as a developer, why would you build a new rental structure if you knew there was a cap on how much you could make? After all, the price of everything else, like maintenance, insurance, property taxes and utilities would still be going up.
Your profits would get squeezed until you had none. So you'd take your business elsewhere. At the end of the day, rent controls would cut back on the real estate investments flowing into New York.
Without investments, people would lose their jobs. And just as quickly as things improved because of the rent controls, they would now start to deteriorate.
The lesson? Price controls are bad.
It doesn't matter if it is rent, groceries, or toys. When the government tries to control the price of any one thing, it completely skews the market.
This applies to the price of credit through interest rates as well.
Currently, the Fed has a cap on short-term interest rates of 0-0.25%. And they are now targeting long-term rates, too. Remember, banks are in the business of lending money. And if they perceive risk as higher than usual, they will demand a higher interest rate for that loan.
And you'd think they would do most of their lending to the least risky parts of the economy. Let's see if that's true.
Typically a bank has five big types of lending it can do.
Consumption (for the consumer), business fixed investment, residential fixed investment, government, and exporters.
The blue box represents the current recovery, and the red box represents the average of the three previous recoveries.
Because of the housing bust, banks aren't lending to housing developers (see how the middle blue box is below the "0" line). Interest rates are far too low to justify the risk.
And since consumers are so strapped with debt, banks aren't lending to them either (the blue box on the far left). They are only lending to the consumers with the best credit scores and a big down payment.
Since states are so cash-strapped, lending to states has gone down too (the second blue box from the right).
The only lending that has increased substantially is for exporters (the blue box on the far right) and business fixed investment (the second blue box from the left). These are the only two types of lending that banks consider "safe."
So, instead of fueling the economy with new loans, banks are taking their excess cash and parking it at the Fed for a guaranteed 0.25% interest rate.
This is just crazy. When a bank lends out money, it usually makes about a three percent spread on its cash. The fact that banks would rather park their money at the Fed for a quarter percent, instead of lending it and making three percent, means that banks still think there is too much risk in the economy.
Even crazier is that the banks are right.
They realize that most of the assets on the balance sheet of other US banks are worth less than they're admitting. If banks were forced to write down their assets to the true market value, most of them would be completely insolvent today.
The economy would probably collapse as a result.
In essence, banks are faking it to stay alive.
And that's just one part of the equation. Why would banks lend money out to people that already have too much debt to begin with? Odds are, they will default and the bank will wind up losing money.
Three percent simply doesn't cover their risk.
So, in essence, the Fed's low-interest rate policy is helping to unravel our economy.
There's another incentive for Federal Reserve Chief Ben Bernanke to keep interest rates low. Because he can spend, spend, spend! Why? Because the money the government would spend on interest for its new loans is basically nothing. Not only do low interest rates encourage Uncle Sam to spend more, he could now afford to take out more loans.
So our debt has now skyrocketed. And as long as interest rates stay as low as they are today, debt as cheap as it is will continue to climb.
You have to look no further than Japan for a real-world example of this very phenomenon.
That country has had super-low interest rates for two decades now. Has it helped the country at all? On the contrary, Japan is still dealing with deflation. Not only that, but thanks to dozens of "stimulus packages," it now has the highest debt levels of any industrialized nation in the world at nearly 200% of GDP.
That's $8 trillion!
It's easy to keep that debt rolling over when interest rates are at zero percent. But what happens when interest rates finally start moving higher? Japan will be in a world of trouble, as well as the US when our rates begin to rise.
At that point it would be extremely difficult for Japan to avoid default. Just think it through…
If Japan defaulted and cut its debt in half, it would still have a 100% debt to GDP ratio. That's incredibly bad. In order to improve things, Japan would have to cut debt an additional 25%.
Bondholders all around the world would lose $6 trillion. And it's a virtual guarantee that Japanese banks (holding much of this debt) would also go belly-up.
Japanese banks know this. And at a zero percent interest rate, they simply aren't being incentivized to make new loans considering the risk that is out there.
I'm afraid that the U.S. is going down a similar path with its ultra-low interest rate policy.
Instead of aiding America, the Fed's low-interest rate policy is helping to unravel our country.
So what can you do? I'll give you three solutions.
The first is to buy gold. The metal recently dropped from $1,900 an ounce to $1,617. That's what I call a deal. Because at the end of the day, the longer the Fed keeps interest rates at zero, more money will be funneled into gold because its potential returns are far higher than what you can find in other assets.
And even with speculators effectively manipulating gold's price on a regular basis (as my colleague Andrew Gordon has shown in his eye-opening investigative report), it's still a "safe haven" for a certain portion of your portfolio.
The second thing you could do, ironically enough, is buy shares of a U.S. dollar ETF. Why would I suggest that? Because the zero interest rate policy that the Fed is engaged in today is causing a sort of deflation to occur. In other words, since banks are lending less, there are fewer dollars floating around the system. So the value of each dollar actually goes up.
Now remember, our Fed could keep interest rates low for years to come (Japan has done it for more than 20 years now!). So instead of losing value, it's very realistic that our dollar could gain value for decades.
Holding the U.S. Dollar ETF will let you make money from this.
And keep in mind that right now, the world economy is struggling. So for the short term, don't be surprised if the dollar gets a boost as people look to put their money in the dollar for safety.
As a side note, usually gold's value and the dollar's value go in inverse directions. If the dollar is up, gold is down. If gold is up, the dollar is down. However, there have been several long-term instances when both travel upward together.
And the third and final thing I want you to consider, is to start investing in developing nations. As our dollar gains value, the currency of other countries will fall. This will make them more competitive and stimulate a lot of growth in those nations. This has already led to some amazing gains over the past few years. And I have no doubt that this could continue for a few more decades.
Even though our Fed is engaging in one of the most destructive policies in U.S. history, if you take these three steps today, you could actually make some money and shelter yourself from what's to come.
Take care,
Charles Delvalle
Financial Analyst
Insider Fortunes
September 30, 2011
Note from Andrew Gordon: My talented analyst, Charles Delvalle, is right about the banks not lending. But I want to add two additional explanations! Reason number one: Cash-rich companies. Why would companies borrow when they're sitting on record amounts of cash? Reason number two: Both corporations and individuals are reducing debt, and saving up for "rainy days."
Dear Insider Fortunes Reader,
Were your parents like mine? Anytime I'd raid the snack counter, they would always tell me: "Too much of a good thing is bad."
Well, the same thing applies to low-interest rates.
During your average recession, lowering interest rates definitely helps stimulate the economy. But when interest rates get too low and stay there for too long, it actually turns into a bad thing.
The best way I can explain this is by showing you something called "price theory." It goes like this…
Let's say a place like New York deems that rents are too high for the average person. So it institutes a price cap on the amount a homeowner can rent his place out for. As a consequence, rents go down across New York, and people fill up all the available apartments.
At first, it'd be a good thing. People would have more money to spend on other things. But at some point, these price controls would actually allow demand to climb way above the available supply.
Now, New York would have a problem – they would have no vacant apartments to rent out. And as an apartment building owner, you would have a problem too. If you can't increase your rent, you lose your incentive to lease out at all. So you sell the apartments you own in New York and buy another apartment building somewhere else where there are no rent controls.
And as a developer, why would you build a new rental structure if you knew there was a cap on how much you could make? After all, the price of everything else, like maintenance, insurance, property taxes and utilities would still be going up.
Your profits would get squeezed until you had none. So you'd take your business elsewhere. At the end of the day, rent controls would cut back on the real estate investments flowing into New York.
Without investments, people would lose their jobs. And just as quickly as things improved because of the rent controls, they would now start to deteriorate.
The lesson? Price controls are bad.
It doesn't matter if it is rent, groceries, or toys. When the government tries to control the price of any one thing, it completely skews the market.
This applies to the price of credit through interest rates as well.
Currently, the Fed has a cap on short-term interest rates of 0-0.25%. And they are now targeting long-term rates, too. Remember, banks are in the business of lending money. And if they perceive risk as higher than usual, they will demand a higher interest rate for that loan.
And you'd think they would do most of their lending to the least risky parts of the economy. Let's see if that's true.
Typically a bank has five big types of lending it can do.
Consumption (for the consumer), business fixed investment, residential fixed investment, government, and exporters.
The blue box represents the current recovery, and the red box represents the average of the three previous recoveries.
Because of the housing bust, banks aren't lending to housing developers (see how the middle blue box is below the "0" line). Interest rates are far too low to justify the risk.
And since consumers are so strapped with debt, banks aren't lending to them either (the blue box on the far left). They are only lending to the consumers with the best credit scores and a big down payment.
Since states are so cash-strapped, lending to states has gone down too (the second blue box from the right).
The only lending that has increased substantially is for exporters (the blue box on the far right) and business fixed investment (the second blue box from the left). These are the only two types of lending that banks consider "safe."
So, instead of fueling the economy with new loans, banks are taking their excess cash and parking it at the Fed for a guaranteed 0.25% interest rate.
This is just crazy. When a bank lends out money, it usually makes about a three percent spread on its cash. The fact that banks would rather park their money at the Fed for a quarter percent, instead of lending it and making three percent, means that banks still think there is too much risk in the economy.
Even crazier is that the banks are right.
They realize that most of the assets on the balance sheet of other US banks are worth less than they're admitting. If banks were forced to write down their assets to the true market value, most of them would be completely insolvent today.
The economy would probably collapse as a result.
In essence, banks are faking it to stay alive.
And that's just one part of the equation. Why would banks lend money out to people that already have too much debt to begin with? Odds are, they will default and the bank will wind up losing money.
Three percent simply doesn't cover their risk.
So, in essence, the Fed's low-interest rate policy is helping to unravel our economy.
There's another incentive for Federal Reserve Chief Ben Bernanke to keep interest rates low. Because he can spend, spend, spend! Why? Because the money the government would spend on interest for its new loans is basically nothing. Not only do low interest rates encourage Uncle Sam to spend more, he could now afford to take out more loans.
So our debt has now skyrocketed. And as long as interest rates stay as low as they are today, debt as cheap as it is will continue to climb.
You have to look no further than Japan for a real-world example of this very phenomenon.
That country has had super-low interest rates for two decades now. Has it helped the country at all? On the contrary, Japan is still dealing with deflation. Not only that, but thanks to dozens of "stimulus packages," it now has the highest debt levels of any industrialized nation in the world at nearly 200% of GDP.
That's $8 trillion!
It's easy to keep that debt rolling over when interest rates are at zero percent. But what happens when interest rates finally start moving higher? Japan will be in a world of trouble, as well as the US when our rates begin to rise.
At that point it would be extremely difficult for Japan to avoid default. Just think it through…
If Japan defaulted and cut its debt in half, it would still have a 100% debt to GDP ratio. That's incredibly bad. In order to improve things, Japan would have to cut debt an additional 25%.
Bondholders all around the world would lose $6 trillion. And it's a virtual guarantee that Japanese banks (holding much of this debt) would also go belly-up.
Japanese banks know this. And at a zero percent interest rate, they simply aren't being incentivized to make new loans considering the risk that is out there.
I'm afraid that the U.S. is going down a similar path with its ultra-low interest rate policy.
Instead of aiding America, the Fed's low-interest rate policy is helping to unravel our country.
So what can you do? I'll give you three solutions.
The first is to buy gold. The metal recently dropped from $1,900 an ounce to $1,617. That's what I call a deal. Because at the end of the day, the longer the Fed keeps interest rates at zero, more money will be funneled into gold because its potential returns are far higher than what you can find in other assets.
And even with speculators effectively manipulating gold's price on a regular basis (as my colleague Andrew Gordon has shown in his eye-opening investigative report), it's still a "safe haven" for a certain portion of your portfolio.
The second thing you could do, ironically enough, is buy shares of a U.S. dollar ETF. Why would I suggest that? Because the zero interest rate policy that the Fed is engaged in today is causing a sort of deflation to occur. In other words, since banks are lending less, there are fewer dollars floating around the system. So the value of each dollar actually goes up.
Now remember, our Fed could keep interest rates low for years to come (Japan has done it for more than 20 years now!). So instead of losing value, it's very realistic that our dollar could gain value for decades.
Holding the U.S. Dollar ETF will let you make money from this.
And keep in mind that right now, the world economy is struggling. So for the short term, don't be surprised if the dollar gets a boost as people look to put their money in the dollar for safety.
As a side note, usually gold's value and the dollar's value go in inverse directions. If the dollar is up, gold is down. If gold is up, the dollar is down. However, there have been several long-term instances when both travel upward together.
And the third and final thing I want you to consider, is to start investing in developing nations. As our dollar gains value, the currency of other countries will fall. This will make them more competitive and stimulate a lot of growth in those nations. This has already led to some amazing gains over the past few years. And I have no doubt that this could continue for a few more decades.
Even though our Fed is engaging in one of the most destructive policies in U.S. history, if you take these three steps today, you could actually make some money and shelter yourself from what's to come.
Take care,
Charles Delvalle
Financial Analyst
Insider Fortunes
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