In his June 21 New York Times article “Is the Era of Cheap Money Over?,” Paul Krugman argues against the view that the Fed has kept interest rates artificially low for the past ten to twenty years. Other commentators have argued that these low interest rates have inflated bubbles everywhere as investors desperately look for something that will yield a decent rate of return.
Krugman expresses strong disagreement that the decline in interest rates caused bubbles and that the decline was artificial. For Krugman, the Federal Reserve sets short-term interest rates, which in turn determine long-term rates. He then suggests that there’s no such thing as an interest rate unaffected by policy.
The columnist then argues that what matters for the Fed’s policy is the natural rate of interest, which is consistent with price stability and economic stability—i.e., economic equilibrium. This means that the key objective of Fed policies should be to target the policy rate to the natural rate in order to attain this state of equilibrium. Given that the natural rate was trending down it is not surprising that the policy rate followed suit.
Why has the natural rate been trending down? According to Krugman, the downtrend was caused by demography. “When the working-age population is growing slowly or even shrinking, there’s much less need for new office parks, shopping malls, even housing, hence weak demand.” Krugman warns, “These demographic forces aren’t going away. If anything, they’re likely to intensify, in part because the rate of immigration has dropped off. So there’s every reason to believe that we’ll fairly soon go back to an era of low interest rates.”
Krugman also says that the Fed’s interest rate policy has been in line with the neutral rate, which fell very sharply. Again, the key reason for this decline is aging population and reduced demand for the investment in the infrastructure. However, does it all make sense?
Interest Rates and the Fed
Again, according to Krugman, the Fed is the key factor for the determination of interest rates via its control of the short-term interest rates. The Fed influences short-term interest rates by influencing monetary liquidity in the markets. Through the injection of liquidity, the Fed pushes short-term interest rates lower. Conversely, by withdrawing liquidity the Fed exerts an upward pressure on the short-term interest rates.
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On this thinking, long-term rates are the average of current and expected short-term interest rates. If today’s one year rate is 4.0 percent and the next year’s one-year rate is expected to be 5.0 percent, then the two-year rate today should be 4.5 percent ((4+5)/2=4.5 percent). Conversely, if today’s one-year rate is 4.0 percent and the next year’s one-year rate expected to be 3.0 percent, then the two-year rate today should be 3.5 percent (4+3)/2=3.5 percent.
On this logic, it would appear that the central bank is the key in the interest rate determination process. However, is this the case?
Individuals’ Time Preferences and Interest Rates
We believe it is individual time preferences rather than the central bank that hold the key in the interest rate determination process. What is it all about?
An individual who has just enough resources to keep himself alive is unlikely to lend or invest his paltry means. The cost of lending, or investing, to him is likely to be very high—it might even cost him his life if he were to consider lending part of his means. Therefore, he is unlikely to lend, or invest even if offered a very high interest rate. Once his wealth starts to expand, the cost of lending, or investing, starts to diminish. Allocating some of his wealth towards lending or investment is going to undermine to a lesser extent our individual’s life and well-being at present.
From this we can infer, all other things being equal, that anything that leads to the expansion in the wealth of individuals is likely to result in the lowering of the premium of present goods versus future goods. This means that individuals are likely to accept lower interest rates.
Note again, interest is the outcome of the fact that individuals assign a greater importance to goods and services in the present against identical goods and services in the future. The higher valuation is not the result of capricious behavior, but because of the fact that life in the future is not possible without sustaining it first in the present. Hence, various goods and services that are required to sustain a man’s life at present must be of a greater importance to him than the same goods and services in the future.
The lowering of time preferences—i.e., the lowering of the premium of present goods versus future goods due to wealth expansion—is likely to become manifest by a greater eagerness to invest wealth. With the expansion in wealth, individuals are likely to increase their demand for various assets—financial and nonfinancial. In the process, this raises asset prices and lowers their yields, all other things being equal.
As a rule, a major factor for the discrepancy between observed interest rates and the time preference interest rate is the actions of the central bank.
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The Neutral Interest Rate Myth
Again, by popular thinking, the neutral rate is one that is consistent with stable prices and a balanced economy. Hence, by this thinking in order to attain economic and price stability, Fed policy makers should navigate the federal funds rate towards the neutral rate range.
By the neutral interest rate framework, in order to establish whether monetary policy is tight or loose it is not enough to pay attention to the level of money market interest rates, but rather one needs to contrast money market interest rates with the neutral rate. Thus if the market interest rate is above the neutral rate then the policy stance is tight. Conversely, if the market rate is below the neutral rate then the policy stance is loose. Hence, whenever the money market rate is in line with the neutral rate, then the economy is in a state of equilibrium and there are neither upward nor downward pressure on the price level.
In the popular framework, the neutral interest rate is formed at the point of intersection between the supply and demand curves. The supply and demand curves as presented by popular economics originates from the imaginary construction of economists. None of the figures that underpin these curves originates in the real world; they are purely imaginary. According to Ludwig von Mises, “It is important to realize that we do not have any knowledge or experience concerning the shape of such curves.”
Consequently, this implies that it is not possible to establish from the imaginary curves the neutral interest rate. The employment of sophisticated mathematical methods does not solve the issue that the neutral rate is not observed. So what are the basis for Krugman to suggest that the neutral rate has been trending down? None whatsoever. Contrary to Krugman, the Fed by being a major source for money creation has been instrumental in the formation of bubbles.
Conclusion
Contrary to Krugman the main source for money creation out of “thin air” is the central bank. Consequently, various bubble activities created are the outcome of the Fed’s monetary pumping and nothing else.
About the Author
Frank Shostak‘s consulting firm, Applied Austrian School Economics, provides in-depth assessments of financial markets and global economies. Contact: email.
Image by 00Joshi via Flickr, CC BY-NC-SA 2.0. Article cross-posted from Mises.
Five Things New “Preppers” Forget When Getting Ready for Bad Times Ahead
The preparedness community is growing faster than it has in decades. Even during peak times such as Y2K, the economic downturn of 2008, and Covid, the vast majority of Americans made sure they had plenty of toilet paper but didn’t really stockpile anything else.
Things have changed. There’s a growing anxiety in this presidential election year that has prompted more Americans to get prepared for crazy events in the future. Some of it is being driven by fearmongers, but there are valid concerns with the economy, food supply, pharmaceuticals, the energy grid, and mass rioting that have pushed average Americans into “prepper” mode.
There are degrees of preparedness. One does not have to be a full-blown “doomsday prepper” living off-grid in a secure Montana bunker in order to be ahead of the curve. In many ways, preparedness isn’t about being able to perfectly handle every conceivable situation. It’s about being less dependent on government for as long as possible. Those who have proper “preps” will not be waiting for FEMA to distribute emergency supplies to the desperate masses.
Below are five things people new to preparedness (and sometimes even those with experience) often forget as they get ready. All five are common sense notions that do not rely on doomsday in order to be useful. It may be nice to own a tank during the apocalypse but there’s not much you can do with it until things get really crazy. The recommendations below can have places in the lives of average Americans whether doomsday comes or not.
Note: The information provided by this publication or any related communications is for informational purposes only and should not be considered as financial advice. We do not provide personalized investment, financial, or legal advice.
Secured Wealth
Whether in the bank or held in a retirement account, most Americans feel that their life’s savings is relatively secure. At least they did until the last couple of years when de-banking, geopolitical turmoil, and the threat of Central Bank Digital Currencies reared their ugly heads.
It behooves Americans to diversify their holdings. If there’s a triggering event or series of events that cripple the financial systems or devalue the U.S. Dollar, wealth can evaporate quickly. To hedge against potential turmoil, many Americans are looking in two directions: Crypto and physical precious metals.
There are huge advantages to cryptocurrencies, but there are also inherent risks because “virtual” money can become challenging to spend. Add in the push by central banks and governments to regulate or even replace cryptocurrencies with their own versions they control and the risks amplify. There’s nothing wrong with cryptocurrencies today but things can change rapidly.
As for physical precious metals, many Americans pay cash to keep plenty on hand in their safe. Rolling over or transferring retirement accounts into self-directed IRAs is also a popular option, but there are caveats. It can often take weeks or even months to get the gold and silver shipped if the owner chooses to close their account. This is why Genesis Gold Group stands out. Their relationship with the depositories allows for rapid closure and shipping, often in less than 10 days from the time the account holder makes their move. This can come in handy if things appear to be heading south.
Lots of Potable Water
One of the biggest shocks that hit new preppers is understanding how much potable water they need in order to survive. Experts claim one gallon of water per person per day is necessary. Even the most conservative estimates put it at over half-a-gallon. That means that for a family of four, they’ll need around 120 gallons of water to survive for a month if the taps turn off and the stores empty out.
Being near a fresh water source, whether it’s a river, lake, or well, is a best practice among experienced preppers. It’s necessary to have a water filter as well, even if the taps are still working. Many refuse to drink tap water even when there is no emergency. Berkey was our previous favorite but they’re under attack from regulators so the Alexapure systems are solid replacements.
For those in the city or away from fresh water sources, storage is the best option. This can be challenging because proper water storage containers take up a lot of room and are difficult to move if the need arises. For “bug in” situations, having a larger container that stores hundreds or even thousands of gallons is better than stacking 1-5 gallon containers. Unfortunately, they won’t be easily transportable and they can cost a lot to install.
Water is critical. If chaos erupts and water infrastructure is compromised, having a large backup supply can be lifesaving.
Pharmaceuticals and Medical Supplies
There are multiple threats specific to the medical supply chain. With Chinese and Indian imports accounting for over 90% of pharmaceutical ingredients in the United States, deteriorating relations could make it impossible to get the medicines and antibiotics many of us need.
Stocking up many prescription medications can be hard. Doctors generally do not like to prescribe large batches of drugs even if they are shelf-stable for extended periods of time. It is a best practice to ask your doctor if they can prescribe a larger amount. Today, some are sympathetic to concerns about pharmacies running out or becoming inaccessible. Tell them your concerns. It’s worth a shot. The worst they can do is say no.
If your doctor is unwilling to help you stock up on medicines, then Jase Medical is a good alternative. Through telehealth, they can prescribe daily meds or antibiotics that are shipped to your door. As proponents of medical freedom, they empathize with those who want to have enough medical supplies on hand in case things go wrong.
Energy Sources
The vast majority of Americans are locked into the grid. This has proven to be a massive liability when the grid goes down. Unfortunately, there are no inexpensive remedies.
Those living off-grid had to either spend a lot of money or effort (or both) to get their alternative energy sources like solar set up. For those who do not want to go so far, it’s still a best practice to have backup power sources. Diesel generators and portable solar panels are the two most popular, and while they’re not inexpensive they are not out of reach of most Americans who are concerned about being without power for extended periods of time.
Natural gas is another necessity for many, but that’s far more challenging to replace. Having alternatives for heating and cooking that can be powered if gas and electric grids go down is important. Have a backup for items that require power such as manual can openers. If you’re stuck eating canned foods for a while and all you have is an electric opener, you’ll have problems.
Don’t Forget the Protein
When most think about “prepping,” they think about their food supply. More Americans are turning to gardening and homesteading as ways to produce their own food. Others are working with local farmers and ranchers to purchase directly from the sources. This is a good idea whether doomsday comes or not, but it’s particularly important if the food supply chain is broken.
Most grocery stores have about one to two weeks worth of food, as do most American households. Grocers rely heavily on truckers to receive their ongoing shipments. In a crisis, the current process can fail. It behooves Americans for multiple reasons to localize their food purchases as much as possible.
Long-term storage is another popular option. Canned foods, MREs, and freeze dried meals are selling out quickly even as prices rise. But one component that is conspicuously absent in shelf-stable food is high-quality protein. Most survival food companies offer low quality “protein buckets” or cans of meat, but they are often barely edible.
Prepper All-Naturals offers premium cuts of steak that have been cooked sous vide and freeze dried to give them a 25-year shelf life. They offer Ribeye, NY Strip, and Tenderloin among others.
Having buckets of beans and rice is a good start, but keeping a solid supply of high-quality protein isn’t just healthier. It can help a family maintain normalcy through crises.
Prepare Without Fear
With all the challenges we face as Americans today, it can be emotionally draining. Citizens are scared and there’s nothing irrational about their concerns. Being prepared and making lifestyle changes to secure necessities can go a long way toward overcoming the fears that plague us. We should hope and pray for the best but prepare for the worst. And if the worst does come, then knowing we did what we could to be ready for it will help us face those challenges with confidence.