No Where to Go But Down

We are in a real quandry. With the Federal Funds rate currently at 2% there is not much opportunity left to move it down. Yet with housing values continuing to drop monthly there is no room to move it up. Given the inverse relationship of higher interest rates to lower home prices the move up would add fuel to the fire at this time. However, moving the rates up is exactly what we need to do.

As I wrote in back in January on this blog, http://newenglandopinion.blogspot.com/2008/01/imminent-probability-of-recession.html, a transparent, plan of Fed funds rates is needed to stimulate investment and build stability. If the Fed were to announce that they were taking down the Fed funds rate to encourage business investment for solid business loans and potential homeowners with solid credit then we might see a softening of the downward spiral. The rate should be set for a specific time period with the announcement that 1/4 quarterly adjustments upward would follow until the rate met the risk-adjusted 10-year average rate of inflation.

Back in July, I wrote a piece titled "The Fed should start moving the Fed Funds Rate up to 5%." At the time oil was peaking at $147 a barrel so some of the conditions have changed but longterm I still believe this is the only way to truly build wealth in our US economy. The following is reprint of this piece:

Attention Federal Reserve: It's time to start moving the Fed Funds Rate up to 5%. That should translate into an 8% Prime rate.

Here's the rationale:

Real companies with real products and real earnings do not need cheap money they can borrow in order to stay in business. Companies like General Electric, United Technologies, Exxon, Kellogg, Walmart, McDonalds, etc. have traditionally done just fine with higher costs of capital.

Savers, like myself, are sick of our substantially less than the real rate of inflation returns that we have been stuck with as money has been passed out like candy by the banks to sketchy businesses, borrowers, and profiteers. I think worthy financial institutions will agree that this scam has not added longterm value to their organizations as witnessed by the 70% decline in the value of financials and the "sitting-on-the-edge-of-ruin" financial condition of some of our largest and oldest financial institutions like Citibank, Bank of America, Bear Stearns (RIP), etc.

Other important reasons for higher rates:

The higher rates will attract greater foreign investment in our country's banks.

The higher rates will increase the value of our dollar against other currencies.

The higher rates will slow down the level of imports reducing the trade deficit

The higher rates will significantly reduce the speculative price inceases in crude reducing the cost to consumers.

The higher rates will fend off inflationary pressures.

The higher rates translated to higher yields on savings instruments and bonds will encourage greater saving rates by consumers.

The higher rates and resulting yields will improve the supplemental income of retired Americans.

Mr. Bernanke are you listening or are you too busy playing with your academic models and other toys you are unwilling to share?

I still feel strongly that higher rates is the proper solution for a strong economy. Time will tell.