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Raising interest rates is the quickest way to move the economy forward

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139445633 e2fabef491 m Raising interest rates is the quickest way to move the economy forward
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Suppose you buy a valuable piece of art for $15,000.  Further suppose that a month later a major economic slowdown occurs and as a result, the amount of money art buyers are paying drops substantially.  Perhaps today, if you wanted to sell the art, you might be able to sell the painting for $10,000.  If you intended to sell the painting, what would you do?  Most likely, you would try to wait for the market to correct and try to recoup the initial investment.  You aren’t motivated to sell the piece of art.  It’s not costing you anything not to sell it, so why not hang on to it.

But what if you bought that piece of art on credit?  Even at a relatively good interest rate of 5 percent, you would still be losing over $60 a month in interest and spending about $300 per month in total payments.  Having that piece of art costs you money every month.  In this case, you are much more motivated to sell the art for $10,000.

However, what if you had a credit card that carried zero interest (or in the range of 0 to 0.25%) and if you can borrow money on that card at will without fees.  In this case, you are not losing substantial money to interest and you can borrow more money whenever cash flow gets tight.  In this case, your debt no longer pressures you to move the problem forward.  Although the market has priced your painting at $10,000, you are behaving as if it is still worth $15,000.  You are arguably denying or deferring reality. 

Now I don’t think there is anything particularly wrong with this delusion.  Everyone can bury their head in the sand, but these people should be penalized to clinging to delusions.  But these days, banks do not feel the pinch.

In a market correction, asset holders need to substantially mark down the price of their assets to get them sold.  In a macroeconomic sense this is called “finding the bottom” where prices come down to a point where sufficient buyers are available to meet demand.  Once the market finds its bottom, new growth occurs. 

150x103 Raising interest rates is the quickest way to move the economy forward
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For years now, banks have reaped the benefits of policy based on monetary theory.  After making loans to millions of people who couldn’t afford them, banks should have been suffering from huge cash flow issues due to the lack of payments and loss of principal on these assets.  However, since banks can borrow money at will from the Federal Reserve at essentially no cost to them, banks have plenty of cash to meet their needs.  Banks have little motivation to turn around their growing foreclosure inventories by reducing prices. 

Because of this false support of overvalued properties, real estate property values continue to fall, not in a quick fashion, but a slow laborious multi-year fashion. When the correction could have taken a year or two, real estate values are still falling.  Wise potential home buyers see this and are choosing not to buy.  It is important to note that record low mortgage rates also played a huge role in driving home sale prices up.  Home buyers realize that once interest prices do rise, there will be even more downward pressure on home prices. 

These phenomena add up to one conclusion, sellers are hesitant to sell and buyers are hesitant to buy.  Raising interest rates, though painful in the short term, may offer the best hope for escaping the economic holding pattern we’ve been in for years.

 Raising interest rates is the quickest way to move the economy forward
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Supply, Demand and the Higher Education Bubble

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In the mid 2000’s, our society saw the largest asset bubble in modern history.  Low interest rates spurred loosening of credit which propelled home sale prices upward.  Operating by simple laws of supply and demand, the abundance of cheap and loose credit meant that there was an abundance of money.  Without a strong constraint on the availability of funds with which to buy homes, there price of homes increases to match the supply.  The crash that began in 2008 was driven in large part of the well of credit drying up.  This caused the supply of money to shrink rapidly.  Again, operating under the simple laws of supply and demand, home prices plummeted. 

For decades, we have been seeing the same process at work in education.  Driven by easy access to low interest credit in the form of Federally backed student loans, the prices of post-secondary education has risen unchecked.  According to inflationdata.com, in 1986, average costs of a 4-year degree was $10,000.  By 2015, costs of a 4-year degree is anticipated to be $120,000.   Between 1985 and 2010, the total cost of education increased more than 485 percent, while the average of all consumer prices increased about 107 percent.

Based on this information, it is apparent to me that higher education costs are a major bubble.  The only reason that bubble hadn’t burst years ago is because the Federal Government has been willing  to continue to lend with reckless abandon.  In 2010, in the wake of ever increasing student loan defaults, combined with a widespread cry for fiscal accountability in government, there finally started some discussions about limited the pool of government funds to be used for new loans.  If and when that pool dries up, finally, there will be a reversal in the cost of a college education.

Unfortunately, this will come too late for those students who will be laboring for decades under the load of loans that in many cases will not result in a large enough income stream to pay them off in a reasonable period of time.

 Supply, Demand and the Higher Education Bubble
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