There are serious downsides to dropping interest rates that are already low. This may sound heretical, given the enthusiasm on Wall Street and in our nation’s capital for the interest rate cut that’s expected to emanate from the Federal Reserve in a few days. But it’s true.
Among other things, making low interest rates ultralow poses dangers to individual and institutional investors who feel compelled to buy stocks because they can’t get decent income from safe, conservative investments such as U.S. Treasury securities.
When the market downturn comes — and it always does, often seemingly out of nowhere — these investors who felt forced into buying stocks will pay a heavy price for their risk taking.
It was one thing for the Fed to push investors into the stock market when it began cutting rates sharply during the Great Recession a decade ago, back when stocks were depressed, the financial system was fragile, and fear was everywhere.
But it’s a whole other thing to displace would-be bond investors into stocks at a time like this when stock prices are high, the economy is doing okay (although not great) and the financial system is no longer living on borrowed time.
The thesis behind the pending Fed rate cut is that the U.S. economy is slowing down and needs a boost. But based on what I’ve learned in almost a half-century of covering markets and finance, I can’t see how the Fed cutting short-term rates (the only ones that it controls directly) will solve the economy-slowing-down problem that seems to be caused largely by President Trump’s trade wars and various uncertainties arising from them.
Yes, I know that lower interest rates are better for borrowers than higher interest rates are. And I also know that in theory, lower rates in and of themselves stimulate the economy.
But do you think that a quarter-point or half-point cut by the Fed will generate job-creating investments in the United States by companies that are uncertain about the future because of trade wars, threatened trade wars, interrupted supply chains and other actual and potential instabilities? I don’t.
Will a Fed rate cut make up for the economic loss that farmers are suffering from trade-war-caused reductions in their exports to China? Will it get Chinese businesses, which are cutting way back on new U.S. investments for political and economic reasons, to resume pouring money into our country? I doubt that, too.
Ultralow interest rates are bad for retirees (including me) who would like to earn a reasonable interest rate on their lifetime savings.
Having retirees who’ve saved for decades subsidize borrowers is a wealth transfer that I don’t find particularly appealing. But you can also make a case that if ultralow rates help the economy and encourage consumer and investor confidence, it’s good for retirees’ kids and grandkids, at least in the short run.
What’s not good for them, however, is the effect that close-to-zero rates have on the Social Security system and on pension funds.
The lower that rates on Treasury securities fall, the less money Social Security makes on its $2.9 trillion trust fund, which consists entirely of Treasury securities.
The less the trust fund earns, the earlier the day of reckoning arrives when the fund goes broke. If that happens — which I used to think was impossible but in these days of D.C. dysfunction, who knows? — payments to Social Security recipients will drop about 20 percent, a catastrophic cut for many of them.
Ultralow rates are also bad — if not catastrophic — for pension funds, especially way-underfunded government pension funds like those in my home state of New Jersey.
If pension funds can’t make their targeted rate of return on their bond holdings, which these days they can’t, they’re going to continue putting more and more money into stocks and risky, high-cost esoterica such as “private equity” funds and venture capital. Loading up on high-cost, high-risk assets tends not to end well.
And ultralow rates are bad for life insurance and long-term care insurance companies, which take your premium payments, invest them, and expect to earn more than enough on them to cover the cost when you croak or end up in a nursing home.
I don’t expect people to be upset about insurance companies’ problems — but when premiums rise, which is inevitable unless interest rates rise, pains and problems will ensue.
If you want a real-world example of how ultralow rates aren’t cure-alls, look at Germany, where interest rates are negative (which means that lenders are in effect paying borrowers for the right to lend them money) but the economy is nevertheless weakening.
The idea that pushing rates even farther below zero will miraculously solve the economic problems of Germany and other European countries makes no sense to me.
But then again, I’m not sure that the point of European and Fed rate cuts is to make sense. It’s to follow conventional economic wisdom. Which in this case, I think, will turn out not to be very wise at all.