Quit Whining About Low Rates

04/26/2012 11:47 am EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

The Fed chief parried criticism from both sides of the rate debate yesterday and was much too polite to one, writes MoneyShow.com senior editor Igor Greenwald.

The Federal Reserve sure kept its reserve yesterday. The economy’s steering committee was content to stay the course, merely tweaking its play-by-play a bit to account for the European mess and the recent run of weaker data.

The recent slowing of the recovery shaped the questions Fed Chairman Ben Bernanke faced in his quarterly press conference, with a couple of the early ones pressing him to explain why the Fed isn’t doing even more given the modest inflation and persistently high unemployment.

Bernanke answered that of the Fed is already doing a lot, and would do even more if it thought the benefit of doing so outweighed the risks. But he also emphatically put to bed the fantasy that he’s merely looking for a convenient excuse to unleash the next round of asset purchases.

“We’re doing a great deal; policy is extraordinarily accommodative,” the Fed chairman said.

“The question is, does it make sense to actively seek a higher inflation rate in order to achieve a slightly increased pace of a reduction in the unemployment rate? The view of the committee is that that would be very reckless.

"We the Federal Reserve have spent 30 years building up credibility for low and stable inflation, which has proved extremely valuable in that we've been able to take strong accommodative actions in the last four to five years to support the economy, without leading to [higher] inflation expectations. To risk that asset for what I think would be quite tentative and perhaps doubtful gains would be an unwise thing to do.”

But of course, that’s not good enough for those gravely concerned about what the low interest rates are doing to all the widows, orphans, and (entirely coincidentally, of course) holders of large Cayman Islands bank accounts.

In fact, the widows and orphans are mostly cared for by the government whose fiscal difficulties would get infinitely worse were the Fed to start raising rates before tax revenue recovered. And many retirees dependent on income from bond funds have been amply compensated with big capital gains thanks to the bond rally.

Then too there’s the fact, covered here before, that the overwhelming majority of income is reaped by the very rich, who can and have avail themselves of many other income-boosting opportunities in this “financial repression” we’re said to be suffering.

But the carping just never stops. The latest critic is none other Sheila Bair, the former Federal Deposit Insurance Corp. chairman who frequently clashed with Bernanke in the jockeying over who would regulate what under the Frank-Dodd financial reform law.

In her latest column for Fortune, Bair urges the Fed to pop the “bond bubble.” She argues that low rates merely produce “paper gains” in the stock market and give refinancing homeowners more money to spend on imports, which Bair dismisses as short-term props that merely obscure our problems.

So of course, the CNN reporter at the news conference—representing the same Time Warner (TWX) media empire that publishes Fortune—had to get Bernanke’s opinion on Bair’s column as the press conference was winding down. The Fed chairman politely replied that “it’s a little premature to declare victory” and noted that rates are low for a number of reasons, notably “the weak economy.”

Paul Krugman had already made a polite rebuttal of his own, pointing out the huge slack in the labor market.

So I guess it’s up to me to be rude in the face of persistent obstinacy: interest-rate crybabies, quit your whining. You don’t have a natural right to earn a preconceived interest rate regardless of the economy’s performance.

What do you think banks need your money for? To lend to employers who’re running much leaner than they were five years ago against the possibility that all the people they laid off will waltz through the front door to buy more product? Or to invest in Treasuries earning 2% and facing the very real threat of big capital losses when rates rise? Why exactly do you think you deserve more interest?

Let’s imagine that the Fed had come out yesterday and said, “Never mind what we said before; we’re raising rates so you can earn 2% on your savings account.”

In Austrian-economics-school fantasies, this is where the confidence fairy settles simultaneously on everyone’s shoulder and chirps, “Hey, the Fed is confident, you should be too,” and we all live happily ever after.

The more probable outcome is that the Dow suffers an immediate 1,000-point drop, corporate investment grinds to a halt, and the slump in housing prices kicks into overdrive.

Under that scenario, the long-term bond yields would quickly approach shorter-term ones as investors braced for a recession. And you still wouldn’t earn anything on that savings account, because the economy simply isn’t strong enough right now to reward risk-free saving.

And if you think the shortage of interest income is the worst problem we’ve got, you simply haven’t been paying attention.

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