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It has been predicted by many financial analysts that the interest rates which central banks around the world set their prices at is about to swiftly move upward due to years of keeping them artificially low. The long term effects of artificially keeping interest rates low are well known among sound economists and financial people for many years, but has fallen on deaf ears with Keynesian minded people and governments.
Interest rates have been set at unprecedented low levels for about a year now in many countries including the United States where the current interest rates stands close to zero per cent. The reason for this setting is that Keynesian economic planners believe that it is their duty to manipulate interest rates which ultimately affect the market in the long term, but to manipulate them for short-term gains in the economy. Typically a central bank controls certain types of short-term interest rates. These influence the stock- and bond markets as well as mortgage and other interest rates. The European Central Bank for example announces its interest rate at the meeting of its Governing Council; in the case of the Federal Reserve, the Board of Governors (Wikipedia, 2009).
Low interest rates tend to stimulate borrowing from the banking system. This expansion of credit causes an expansion of the supply of money, through the money creation process in a fractional reserve banking system. This in turn leads to an unsustainable “monetary boom” during which the “artificially stimulated” borrowing seeks out diminishing investment opportunities (Wikipedia, 2009). This is where the world finds itself in trouble now that interest rates were kept too low for too long. World economies are now feeling the effects of excess liquidity in the markets.
Peter Schiff provided commentary on this ideology recently: “The reality is, that if we put interest rates anywhere near where they ought to be, we would bankrupt most of our financial entities and we’d have a real collapse. We’re never going to have a real recovery until the market lets us have a real recession. Our phony consumer-based economy isn’t viable; it only exists as long as the Chinese and Japanese lend us money to buy their stuff” (Peter Schiff, 2009). As we can see from the below chart, interest rates have been artificially low for quite some time.
We’re already starting to see interest rate reversals in places like Australia where interest rates were lowerered — albeit not as low as maybe the USA, but historically low for them — to counter the effects like inflation that inevitably follow years of ‘quantitative easing’ or excessive printing of currencies.
Stocks, Commodities Climb as Australia Raises Interest Rates
Oct. 6 (Bloomberg) — Stocks rose around the world and commodities rallied as Australia unexpectedly increased interest rates, the first Group of 20 nation to do so since the recession began, amid evidence the recovery is gathering momentum. The Reserve Bank of Australia’s decision to boost the overnight cash rate target to 3.25 percent from a 49-year low of 3 percent followed the first expansion this year in U.S. service industries.
“If there was a country that would be first to hike, then Australia was always a strong candidate,” wrote Jim Reid, a strategist at Deutsche Bank AG in London, in a report. “What it does remind us is how quickly things can change in both directions. The prospect of no rate changes, or no accidents, in the largest world economies over the next 12 to 18 months seems unlikely.”
This data is found at Bloomberg
There was a similar turn of events where interest rates worldwide skyrocketed to double-digit numbers during the recession of the 1980s with Paul Volcker at the helm of the Federal Reserve Bank.
Greenspan predicts double-digit rates in coming years
WASHINGTON — A day before the Federal Reserve is expected to cut interest rates, former Fed chairman Alan Greenspan predicts in an interview and in a new book out Monday that the Fed will have to raise rates to double-digit levels in coming years to thwart inflation.
Greenspan’s prediction comes a day before Fed officials are widely expected to cut interest rates for the first time in more than four years following turmoil in mortgage markets that has rippled through the entire financial sector, leading to concerns about a credit crunch and a slowdown in the overall economy.
You can find more information about Greenspan’s statement here at USA Today
Rising interest rates will surely have an effect on the economy as it will impede the sale of houses due to the increase in mortgage rates, and will surely affect the credit market in general. Apparently, it is a balancing act for the central banks of the world and one that will probably ultimately fail just because nobody, not even a computer, can accurately predict or set what interest rates should be at what level.
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This entry was posted on Tuesday, October 6th, 2009 at 7:37 pm and is filed under Main Street. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.