Last week we talked about some of the negative aspects of rising interest rates. This week we will outline the positive economic impact of a rising interest rate.
In an ideal world, reversion to a 6% bank lending rate would be healthy. Loan rates for business purposes would be around 6% interest and the corresponding bank depositors would be compensated with 3% to 4% on their savings.
Bankers and lenders would be forced to thoroughly assess the viability of the borrower to actually pay back the interest and the principle.
Small and medium sized business people would need to seriously consider the merits of their business idea and gauge whether it is worthwhile and financially feasible to expand.
At a 6% interest rate, it would be less likely for a CEO to justify borrowing $1B to finance the buy-back of his company stock, increasing the price, resulting in all-too-common multi million dollar annual bonuses without actually producing any real value.
However, it may take some time for a healthy interest rate level to be reinstated. Pushing rates up too quickly could cause a critical decline in both the housing and bond markets. That being said, let’s hope we can rely on the leadership within governments and central banks to nurture along today’s economy and arrange a “soft landing” in the restoration of a healthy borrowing/lending climate.
We are already seeing positive signs. Current headlines are announcing optimism:
“Apple to pay $38-billion in U.S. taxes on foreign cash, open second U.S. campus”
“If Caterpillar Keeps Chewing up Market Share, Stock Could Roll to $116”
In addition, the following chart depicts global manufacturing expansion:
These are all very encouraging signs that everyday businesses are becoming more enthusiastic about producing more innovative products and services. We need to get away from the financial engineering (the manipulation of interest rates to extremely low levels) happening over the last 10 years, which seemed to have only benefit the ultra wealthy.
Healthier interest rates should help encourage an economy where the playing field is leveled, competition can flourish, and we see true price discovery for that currently overpriced home that you want to buy.
You’ve probably often heard us say farmers are the largest generators of “real wealth”. What do we mean real wealth? Farmers take seed, sunlight, rain, and soil, add a few nutrients and fertilizer and wait. Voila! They have created a valuable product that people need and are willing to pay for.
Of course that is very simplified example, which discredits other aspects like management skills and the hard work we know farmers endure, but you get the picture.
Of course these predictions are all opinion based and we are almost guaranteed to be wrong in someways, but that’s what makes these posts fun to write. Now we have a benchmark that will allow us to compare as the events actually unfold.
Key Benefits of Increasing Interest Rates:
- Higher return for savers.
- It can lower inflation rates.
- Banks are forced to be prudent in their lending.
- Businesses and especially large corporations are forced into a position where they need to generate real value rather than manipulate the numbers.