The Zero Interest Program Is Doing Great Damage To Our Economy

Today, The Federal Reserve Indicated they would extend Zero Interest Rates beyond Mid-2013. This Zero Interest Rate Policy (ZIRP) is doing great damage to our economy. Here are a few reasons why:

1. ZIRP punishes savers and forces people to take on additional risk in order to earn needed income. Also, we need savings in order to get investment capital
2. ZRP hurts pension funds and insurance companies who depend on interest income to pay pensioners and cover insurance losses
3. ZIRP distorts prices and encourages malinvestments and new bubbles
4. ZIRP allows banks to make money from the carry-trade (by borrowing from the Federal Reserve at zero and then buying long-term Treasury bonds and capturing the difference in interest) basically risk free. We know the banks need the money.
5. ZIRP is not the way to get consumer spending back to bubble levels because the consumer credit cards are maxed out.

Also, the Federal Reserve is making things even worse with their latest “Twist” program.

This program has the Fed selling its short-term bonds (because demand is high due to world turmoil) and buying long-term bonds (10-30 years in maturity.) This is their attempt to drive down long-term interest rates to “help” the housing industry through lower mortgage rates. Someone should tell them that mortgage rates have been low for several years.

An even bigger problem is inflation. America’s $15 trillion in debt is currently financed at very low rates with an average maturity of less than five years. What happens when inflation hits and drives interest rates to the point where we cannot afford to refinance the debt we currently have? Look at the interest rates Europe is paying to get an idea (Greece two year bonds at 200% and Italy’s 10 year bonds at 8%.) Multiply that by $15 on our way to $20 trillion dollars.

What do you think is going to happen when the Federal Reserve stops buying Treasuries (the way they keep the rates down) and lets the market set interest rates based on time preference (how much interest one is willing to pay to buy the product now versus sometime in the future) and risk.

Be aware of what you can do in the current environment and prepare for higher interest rates in the future.