of living (known as the rate of inflation) burst through 10 percent on its way to 14 percent. Interest rates, which are what bondholders receive when they lend their money to corporations and governments, followed inflation skyward.
In recent years, interest rates have been very low. Therefore, the rate of interest that investors can earn lending their money has dropped accordingly. Although low interest rates reduce the interest income that comes in, the corresponding low rate of inflation doesn’t devour the purchasing power of your principal balance. That’s why lower interest rates aren’t necessarily worse, and higher interest rates aren’t necessarily better as you try to live off your investment income.
UNDERSTANDING SUPER-LOW (AND NEGATIVE) INTEREST RATES
In the aftermath of the 2008 financial crisis, interest rates were at rock-bottom levels. And then they went even lower in some countries. In fact, in a number of European countries and Japan, interest rates have at times been negative — as in less than zero.
What the heck is a negative interest rate, and what exactly does that mean? Normally, when an investor buys a government bond for, say, $10,000, the bond issuer pays the investor interest — such as 3 percent per year. So, the investor would get paid $300 of interest annually. Suppose the governments of Germany, Japan, or Switzerland issue $10,000 bonds that have a negative interest rate — at, say, minus 1 percent per year. In that case, those bond buyers would pay the government bond issuer $100 per year for the privilege of holding their bond!
Why on earth would an investor ever willingly agree to buy a bond with a negative interest rate? It can happen in a country where there’s low demand for borrowing money (due typically to a weak economy) and where investors are more concerned with preserving their money than they are with risking and attempting to grow their money. By literally paying a person or company to borrow money, negative rates may encourage people to take risks/actions that can help the economy.
One final perceived benefit of negative rates is that they are viewed as leading to devaluing that country’s currency. Foreign investors generally aren’t going to be lining up to buy bonds with a negative interest rate! In theory, a devaluing currency helps a country with lowering the effective price of its exports.
Exploring the role of the Federal Reserve
When the chairman of the Federal Reserve Board speaks (currently, it’s Jerome Powell; before him, it was Janet Yellen; and before her, it was Ben Bernanke), an extraordinary number of people listen. Most financial market watchers and the media want to know what the Federal Reserve has decided to do about monetary policy. The Federal Reserve is the central bank of the United States. The Federal Reserve Board comprises the 12 presidents from the respective Federal Reserve district banks and the 7 Federal Reserve governors, including the chairman who conducts the Federal Open Market Committee meetings behind closed doors eight times a year.
Buying money is no different from buying lettuce, computers, or sneakers. All these products and goods cost you dollars when you buy them. The cost of money is the interest rate that you must pay to borrow it. And the cost or interest rate of money is determined by many factors that ultimately influence the supply of and demand for money.
The Fed, from time to time and in different ways, attempts to influence the supply of and demand for money and the cost of money. To this end, the Fed raises or lowers short-term interest rates, primarily by buying and selling U.S. Treasury bills on the open market. Through this trading activity, known as open market operations, the Fed is able to target the Federal funds rate — the rate at which banks borrow from one another overnight.
The senior officials at the Fed readily admit that the economy is quite complex and affected by many things, so it’s difficult to predict where the economy is heading. If forecasting and influencing markets are such difficult undertakings, why does the Fed exist? Well, the Fed officials believe that they can have a positive influence in creating a healthy overall economic environment — one in which inflation is low and growth proceeds at a modest pace.
Over the years, the Fed has come under attack for various reasons. Various pundits accused former Fed Chairman Alan Greenspan of causing speculative bubbles, such as the boom in technology stock prices in the late 1990s or in housing in the early 2000s. Some economists have argued that the Federal Reserve has, at times, goosed the economy by loosening up on the money supply, which leads to a growth spurt in the economy and a booming stock market, just in time to make El Presidente look good prior to an election. Conveniently, the consequences of inflation take longer to show up — they’re not evident until after the election. In recent years, others have questioned the Fed’s ability to largely do what it wants without accountability.
What the heck is “quantitative easing”?
During and after the 2008 financial crisis, many pundits interviewed on financial cable television programs and website pontificators used the Federal Reserve as a punching bag, blaming the Fed for various economic problems, including the 2008 financial crisis. Despite the rebounding economy and stock market, some of the critics got even more vocal in blasting the Fed’s quantitative easing program begun late in 2010. (It’s worth noting that this program was again used in 2020 during the COVID-19 pandemic and government-mandated economic shutdowns.)
More often than not, these critics, who typically and erroneously claim to have predicted the 2008 crisis, have an agenda to appear smarter than everyone else, including the Fed. Some of these pseudo-experts are precious metals hucksters and thus like to claim that the Fed is going to cause hyperinflation that will impoverish you unless
