“Last week, we put a driver into a brand new Mustang. He had a 550 credit score and we got him zero percent financing!”
That’s the story I heard on the radio yesterday afternoon as I took my daughter to cheer practice.
The commercial kicked off a great conversation with Rebekah about debt, interest rates, credit scores, and how our economy works.
Unfortunately, my explanation got us both thinking about just how dangerous debt levels have become, and how many consumers and savers will suffer because of the level of debt in our nation…
Debt and the U.S. Economy
To say that debt fuels the American economy would be the understatement of the century.
Corporations borrow vast sums of money to fund their businesses. Sometimes the debt is put to good use and helps to grow profits. And sometimes that debt becomes an insurmountable challenge in which interest expense erodes profits and causes companies to declare bankruptcy.
Individual Americans are hardly any better.
We borrow money to fund just about any expense.
- From college educations, to home purchases…
- From refrigerators to big screen TVs…
- We finance vacations and remodel projects…
- Don’t forget about your car loan (or multiple car loans for the 2 or 3 car garage)
Even clothes, groceries and frivolous purchases are paid for with credit cards… Cards that may or may not be paid off at the end of the month. And of course those cards typically carry hefty interest rates that eat away at what we could be spending next year at this time.
And all of this debt pales in comparison to the $19.9 trillion (and counting) in debt carried by the U.S. government. That’s more than $165,000 worth of debt for every single taxpayer!1
Yes, the United States economy now rests heavily on a foundation of debt. And this level of debt has enormous implications for investors who want to grow and protect their wealth for retirement.
Why the Fed Can’t (and Won’t) Aggressively Hike Interest Rates
My debt conversation with Rebekah was particularly timely because of the Fed interest rate decision this week.
As you’ve probably heard, the Federal Open Market Committee has been holding its regularly scheduled meeting this week. Today at 2:00, the Fed will release its statement on target interest rates, and Chairman Janet Yellen will follow the statement with a press briefing.
Investors and economists have priced in a near 100% chance that the Fed will increase its target interest rate to a range of 1.00% to 1.25%.
CNBC commentators, Wall Street Journal authors, and plenty of other “talking heads” have been telling investors what to expect in this era of “rising interest rates.”
Well, I’m here to tell you that these commentators are dead wrong.
We’re actually NOT in an era of rising interest rates, and we will NOT be seeing materially higher rates any time soon. Perhaps not in my lifetime — and maybe not even in my children’s lifetime.
That’s because interest rates cannot rise without causing tremendous damage to our economy. And despite the Fed’s few recent hikes, real interest rates — the interest rates that you and I pay on autos, mortgages and credit cards — are holding steady.
Just take a look at the yield on 10-year treasury notes below.
This is one of the main barometers for interest rates that lenders charge borrowers. It has been in a relatively narrow trading range despite the handful of rate hikes made by the Fed.
There’s a big difference between the target interest rate that the Fed sets for banks to loan money to each other, and the actual interest rates that businesses and consumers pay to borrow money…
The U.S. Economy Needs Low Rates and Inflation
Here’s the thing… The Fed knows that the U.S. economy needs real interest rates to stay low.
And so, the Fed will only be able to raise its target interest rate so far before higher rates start to weigh on the economy. In fact the Fed is likely only raising rates now so that the committee can cut rates in the future to help ward off a recession.
The real rates that borrowers pay simply must stay low.
This way, corporations can borrow for growth, and hire more workers.
This way, individuals can borrow more cash to fund purchases (and keep those same companies in business).
And this way, the government can continue to expand its deficit and still cover the interest payments on ballooning federal debt. It’s the only way this system works.
Inflation also plays a key role in the debt story too.
That’s because inflation is the only way that corporations, individuals and the U.S. government will ever have a shot at managing debt levels.
You see, if inflation picks up, the value of each U.S. dollar will be less. And while that sounds like a bad thing for those of us who have responsibly saved dollars for retirement, it’s actually a very good thing for irresponsible borrowers.
That’s because each dollar of debt becomes a little smaller in an inflationary environment.
If wages rise, and the value of assets rise, and the real value of dollars (and debt) declines, then it will be much easier for borrowers to pay down debt levels. Inflation means each dollar will be cheaper (and easier to earn or sell assets for), which makes excessive debt levels easier to pay for.
So don’t expect the Fed to fight back against inflation, or to significantly raise rates anytime soon.
Sure, this afternoon the Fed will hike rates by a paltry 0.25%.
Sure, Janet Yellen will discuss her view of the economy, and talk about being “vigilant” when it comes to inflation.
Make sure you take all of this with a grain of salt.
After all… Yellen, the Fed, the U.S. government, U.S. corporations, and your fellow citizens all need low interest rates, and high inflation, to dig out of the pit of debt they are in.
We’ll continue to discuss opportunities for you to grow and protect your wealth in an era of low interest rates, high inflation, and mounting debt along the way.
Here’s to growing and protecting your wealth!