In Praise Of High Interest Rates

Mod Note: This is a syndication from Jared's Daily Dirtnap daily market newsletter. WSO readers qualify for a $100 discount...just email [email protected] and mention "WSO Monkey Discount" You can follow Jared on twitter at @dailydirtnap

There I go thinking again, but I was thinking the other day about all these housing bubbles around the world (U.S., Spain, and now Canada and Australia), and I’m telling you ahead of time that this is not going to be a rant about the evils of central banking; you can go read that on a blog. Really what this is about is the evils of low interest rates, regardless of whether they are determined by market or by fiat.

Low interest rates are bad. Bad bad bad. They encourage people to take stupid risks. Of course there were a lot of catalysts and causes for the housing bubble here, including poor incentives surrounding lending standards, but most of it stems from the fact that interest rates at the front end were one percent for a long time, which, in hindsight, turned out to be a huge mistake, because the 2002-2003 recession turned out to be very mild. The response to that recession was all out of proportion to the severity of it. Easy for me to say, Mister Monday Morning Quarterback, because at the time, the stock bubble had just blown sky-high and people were talking about a depression. But then again, you could make the argument that the stock bubble was a product of low interest rates, too.

Say what you want about Paul Volcker (and I have), but things were just fine when interest rates were high. When interest rates are high, it makes it hard to buy a house. You really have to have your act together. The payments become prohibitively high, so you have to put more money down, or have a really high income, which discourages homeownership among people who really shouldn’t have a home in the first place. Those years of double-digit interest rates just took all the slack and fat out of the economy and made this country lean and mean. Volcker himself probably had no idea what public benefit he was bestowing on us. You can say the same thing about a strong currency. High interest rates, strong currency, booyah.

Alan Greenspan was many things, and you can’t really pigeonhole him as an interest rate dove or a dovish central banker, but he believed (unless you subscribe to the double agent for capitalism theory, which I don’t) in the judgment of the Federal Reserve Chairman to decide what interest rate was best for the economy. In 1997, and in 1998, Greenspan saw what he believed to be big tail risks that could drop a daisy cutter on the economy (the Asian financial crisis, and the Russian debt default, respectively), and he may have been right; you cannot run a controlled experiment. Back then, people liked to talk about ye olde Greenspan Put, and moral hazard, and they were definitely right. Likely the economy would have survived just fine in 1997 and 1998 and 2000 (Y2K) without all the extra liquidity. Mistakes were made.

Funny, there has been this debate about hawkishness and dovishness going all the way back to the creation of the Federal Reserve back in 1912. It was the Eastern States who had been through a round of inflation (though long ago) who were very cautious and were willing to trade off some growth, but it was the Western states who wanted very easy monetary policy to help finance the numerous capital projects in the area. And so hawkishness and dovishness were born.

Interestingly, interest rates, in my opinion, have less to do with inflation and more to do with risk-taking. Of course, in 2013, people like to talk about “excessive risk” that people are taking (especially in the instance of the “systemically important” banks), but really, it is a lot harder to take risk when rates are significantly positive. Try making money as a pass-thru trader with short rates at five percent. I will go back to what I said before: everything is a carry trade. High interest rates separate out the talent from the pretenders.

Low interest rates create distortions. Zero interest rates create massive distortions. If I were king central bank dude, even in the middle of this recession, I would have positive interest rates now. All kinds of wackiness happens around the lower bound. Don’t believe me? Come to Myrtle Beach. They are building houses like crackerjacks all over again.

I suppose I could go on some Austrian economic diatribe about money and credit expansion, but I’ll pass on that, too. The point of this essay is really to say that I just don’t like dovish central bankers, and that it has less to do with inflation than you might think. It is about discipline. Hawkish central bankers squeeze all the excess out of an economy. Give me a strong dollar, high interest rates, and reasonable taxation and regulation, and of course, minimal corruption and strong property rights, here or in any country, and watch it grow to the sky.

 

This was an awesome post, really really informative... wish I could SB you Dillian. I just have one question that I'm hoping you could provide some insight on. From my understanding, a strong currency discourages international trade. Would a strong dollar, at this point, have a bad impact on exports, which then could possibly drive down demand in our domestic industries? Do net exports not have too much of a weight on GDP? Sorry if these questions are really basic.

EDIT: Just thought of a couple other questions! Let's say the Fed raises interest rates to double-digits, which is supposed to deter risk-takers from taking out loans, etc etc. Doesn't this lead to an overall decrease in demand for home loans, which is synonymous with a decrease in demand to buy homes, which leads to a decrease in demand for home-builders to build homes, which basically results in a domino effect on the housing sector? Would this just be a short-term malady, with the market self-correcting itself in the long run, in true Austrian economic fashion?

 
Best Response

Debitis ipsum rerum expedita possimus. Quod veniam soluta ex sunt iste esse quod. Repellat non consequatur praesentium quaerat. Sint est et illum est rerum id et. Et dolor est non ut dolores et aut.

Aut excepturi debitis et enim. Quis in saepe reprehenderit exercitationem adipisci cum. Totam esse dicta accusantium omnis nemo id.

Career Advancement Opportunities

March 2024 Investment Banking

  • Jefferies & Company 02 99.4%
  • Goldman Sachs 19 98.8%
  • Harris Williams & Co. (++) 98.3%
  • Lazard Freres 02 97.7%
  • JPMorgan Chase 03 97.1%

Overall Employee Satisfaction

March 2024 Investment Banking

  • Harris Williams & Co. 18 99.4%
  • JPMorgan Chase 10 98.8%
  • Lazard Freres 05 98.3%
  • Morgan Stanley 07 97.7%
  • William Blair 03 97.1%

Professional Growth Opportunities

March 2024 Investment Banking

  • Lazard Freres 01 99.4%
  • Jefferies & Company 02 98.8%
  • Goldman Sachs 17 98.3%
  • Moelis & Company 07 97.7%
  • JPMorgan Chase 05 97.1%

Total Avg Compensation

March 2024 Investment Banking

  • Director/MD (5) $648
  • Vice President (19) $385
  • Associates (86) $261
  • 3rd+ Year Analyst (13) $181
  • Intern/Summer Associate (33) $170
  • 2nd Year Analyst (66) $168
  • 1st Year Analyst (202) $159
  • Intern/Summer Analyst (144) $101
notes
16 IB Interviews Notes

“... there’s no excuse to not take advantage of the resources out there available to you. Best value for your $ are the...”

Leaderboard

1
redever's picture
redever
99.2
2
Secyh62's picture
Secyh62
99.0
3
Betsy Massar's picture
Betsy Massar
99.0
4
BankonBanking's picture
BankonBanking
99.0
5
dosk17's picture
dosk17
98.9
6
DrApeman's picture
DrApeman
98.9
7
kanon's picture
kanon
98.9
8
CompBanker's picture
CompBanker
98.9
9
GameTheory's picture
GameTheory
98.9
10
Jamoldo's picture
Jamoldo
98.8
success
From 10 rejections to 1 dream investment banking internship

“... I believe it was the single biggest reason why I ended up with an offer...”