Today the Federal Reserve lowered their key rate to 0%. Huh? How does our economy work when money is lent for no interest? Well, they technically lowered the key rate to a range of 0% to 0.25%. This is the first time the Fed’s key rate has been this low ever. Without getting into a long, complex examination of this let’s take a very simple look at our economic problems:
- Consumers spent more money than they had by borrowing and going into debt
- Lenders lent money to consumers who did not have the capacity to repay the loans
- The government spent more money than it had by borrowing and increasing debt
- Lenders lent money to the government who does not have the capacity to repay the loans
If we had a free market, lenders would be charging 20% interest today to compensate for the fact that it is extremely risky to lend to a population of borrowers whose capacity to repay loans is questionable at best. But, this is only a freeish market, and the Fed gets to fool with parts of the market. Part of what they do is manipulate interest rates. Interest rate cuts are a move to try to get lenders to lend and borrowers to borrow.
If borrowers (corporations and people) don’t have enough income to pay their existing debts, then loaning them money will allow them to pay their old debts. But how will they pay their new debts?
Do you see the problem? The only real way out of this is for the borrower to reduce spending/consumption and increase earnings/production. This includes the government and its citizens.
When you reduce the Fed’s position to what it really is, here’s what it looks like. If they do nothing, our economy will continue to crumble, and we will remove them from power (“Well looks like the Fed failed; let’s get rid of them”), the stock market will continue its decline, unemployment will surge, and faith in the government and our banking system will evaporate. So to avoid this, lenders must give many bad loans to many bad borrowers. Once those borrowers default on the loans, the Fed will then cover the lenders’ losses. The biggest message of the latest Fed happenings is “C’mon, banks, lend money… lots of it and quick. Don’t worry about getting repaid because we [the Fed] will guarantee your loans. If they go bad, we’ll pay you back with money we create.”
Potential Outcomes:
- Borrowers will be disgusted with bad debt and stay far away from borrowing more. Debt-based thinking will come out a failure as we are forced (thank goodness) to return to asset-based thinking.
- Borrowers will borrow more. They will then proceed to default on the debt because they don’t have enough income to repay the loans. Then the Fed will create new money to repay the banks. This will result in trillions of new dollars entering the economy. Unfortunately they will enter by getting into the hands of banks who made bad loans. The result will be a widening of the gap between the haves and have nots. People will have rising expenses (inflation) without rising incomes. Irresponsible financial institutions will have record profits funded by fraud.
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