What Near-Zero Rates Mean for You

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What Near-Zero Rates Mean for You

Larry Jia, International/Finance News Editor

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Ever since the 2008 financial crisis, the Federal Reserve has lowered interest rates to “near-zero” levels, which has continued for the past seven years or so. Signalling rate hikes ever since the “recovery” began half a decade ago, the Federal Reserve Board of Governors has been slow off the blocks almost every time. Yet, we see executives of big banks every morning on CNBC or the Wall Street Journal praising their institution for participating in the “recovery.” The Fed, however, stopped all momentum for Main Street since the recession. Whether it is domestic instability, lack of tangible inflation, or faltering China, bullish Yellen has impeded a real recovery. Why is it that the financial sector has experienced pre-crisis growth, while Main Street is still reeling? Why is it time to finally hike rates substantially?

In the recent half-decade, the financial sector has been experiencing massive growth and recovery in respect to their revenue, cash flow, and net profit. Even Goldman Sachs (GS), who analysts insist fared the best out of all the financial institutions during the Great Recession and has seen the slowest growth, has almost doubled its stock price. The magnates, CEOs, and market leaders have achieved financial prosperity beyond any recovery experienced by the middle class. Jamie Dimon, the chief executive, president, and chairman of JPMorgan Chase (JPM), receives an estimated annual compensation of $21 million in 2013 without bonuses. This payout occurred after a $2 billion loss in Morgan’s London branch. Irresponsible hedging through credit default swaps (CDS) resulted in one of the largest trading losses in the bank’s history.

The middle class, however, and especially recent college-graduates with little experience, still find it difficult to pay rent. Here in Richmond, Virginia, over 3% of Virginia Commonwealth University students default on student loans, one of the highest student loan default rates in the nation and largely due to a market inefficiency in interest rate hikes. Even adults are still finding rent hard to pay, and rainy-day funds nonexistent. A study conducted by Harvard University shows that eleven million Americans contribute over 50% of their monthly income to rent, opposed to the recommended amount of 30%. Nearly half of Americans could not produce $400 for potential rainy days. Although irresponsible money management may be at the root of the issue, consumers and average citizens are still struggling with finances even when Fortune 500’s are thriving.

So how can rate hikes solve anything? Most economists argue that rate hikes are counterproductive to any sort of economic recovery. However, the most obvious issue is that low rates mean lower returns on regular savings accounts. For seniors or non-financial savvy individuals, this could mean the difference between safely retiring or relying on government-funded welfare. Inflation in the past has far outpaced the interest rates at most multinational banks, which actually loses a saver’s money. If $100 is deposited in a savings account with an annual taxable interest rate of 1% (already above industry standard of 0.75-0.9%), at the end of year one, approximately $1 is “earned.” However, the current inflation rate is 0.8%, which means that gains for retirement is minimal or nonexistent. Higher interest rates allow for more and safer saving among everyday Americans. Also, near-zero interest rates give Main Street Americans four basic options: 1) put money in a CD, savings account, or government bond that pays little-to-no interest, 2) invest in professionally-managed accounts, such as mutual funds or index funds, which charge absurd management fees or limit returns to market growth respectively, 3) invest individually in stocks, ETFs, etc., which pose unnecessary risk, especially to seniors, or 4) stuff that cash under your mattress. None of the options above are ideal for your average Joe.

However, instead of simply tightening monetary policy, which just pulls money out of the economy, the Fed just needs to wield its omnipotent power and raise inflationary expectations. Big banks that lend the majority of cash are focused on real interest rates, of which, inflation is among one of two factors. In short, simply increasing inflationary expectations would trigger large financial institutions in raising rates by the same amounts. In theory, this could artificially raise interest rates without the Federal Reserve actually pulling cash from the markets. Regardless, consumers deserve better after suffering through a recession caused by irresponsible lending. If the Fed continues to delay rate hikes because of often inconsequential and temporary news, it should do everything in its power to help the consumers in other ways (including flexing its god-like power). Maybe rates will rise later this autumn, but with its recent track record, stay tuned until the Class of 2019’s graduation day.

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