Five years ago, experts writing for the Wall Street Journal editorial page predicted that inflation and interest rates would be going up soon because of the government's massive deficit spending. Experience would suggest that interest rates can't stay this low forever. However, we're still waiting for the long-predicted "spike" in inflation rates to start happening, and in the meantime, interest rates have adopted a life of their own. They ignore pundits and remain stubbornly low.
Where interest rates go next, and when, can make a difference in the outcome of our investment choices. The world is full of experts like the Wall Street Journal contributors who are still waiting for their predictions to come true. If we had all paid attention to them five years ago, we would not be sitting on stock investments that have increased by 200 percent in the interim -- an outcome resulting, in part, by the economic stimulus of cash created by the Federal Reserve's unrelenting purchase of bonds.
That's why the actions of Janet Yellen, the new chair of the Federal Reserve Board, are so critical, and help explain why she was selected for a reason over Larry Summers. The fact that she was chosen over the former Treasury secretary says a lot about her intellectual capacity as well as her ability to work her way through the minefields of Washington. The chair of the Federal Reserve is considered to be the second-most powerful position in Washington.
Yellen, according to an article about her in the New Yorker magazine, is inclined to favor Main Street over Wall Street, which means that she is inclined to do what is necessary to keep the economy growing. To a Keynesian economist trying to fight a recession, doing what's right means cutting taxes and creating government deficits. Unfortunately, President Bush had already done just that during a period of a strong economy, so there was not a lot of dry powder left when the financial services sector collapsed.
Not so long ago, the actions of the Federal Reserve were said to be sending us down a road to becoming another Greece. Borrowing money to put cash into the economy increased the deficit, but the deficit is only a problem when it becomes a growing percentage of the gross national product. While the national debt in total dollars has increased, the GNP has also benefited from the rising tide of the economy. The percentage relationship has remained about what it was a few years ago.
A book titled "The Armchair Economist" by Steven Landsburg is an entertaining read for someone who wants to understand economics a little better and not be put to sleep.
It's reassuring to read a simple example that illustrates how paying off the debt to save, say, 10 percent in interest costs, takes money out of the economy that would otherwise have made 10 percent. It's an argument for never paying off government debt -- especially if you believe that the private sector can actually make more on its money than the interest cost on the government debt that some are obsessed with paying off. Remember that paying off debt can only be accomplished by increasing taxes or reducing government spending. Both courses threaten to derail any recovery.
As for the future of interest rates and when they might someday rise, it is anyone's guess. The matrix of interest rate influences is so vast that the future is impossible -- even for Wall Street Journal "experts" -- to predict. Investors, however, are free to make informed decisions such as taking advantage of low mortgage rates while they last. If rates continue to stay low, stocks will continue to do well, because low interest rates encourage businesses to borrow and expand.
As the economy continues to improve, higher-yielding bonds that now pay higher interest, but involve more risk, will not be in less danger of default. To the extent that actions of the Federal Reserve have contributed to this condition of well-being, I think we should appreciate the benefits of the additional deficit spending. There's a limit to everything, however, as government spending beyond a point is just wasteful. For my part, I'll trust Yellen's intuition as to when the time might be right to throttle back on easy money.
Steve Butler can be reached at 925-956 0505, ext. 228 or at firstname.lastname@example.org