Just how smart are those Fed guys, anyway?
I’m curious. It seems to be a truism that the Fed lowering interest rates is inherently a way to stimulate the economy – I guess, as I understand it, by making it cheaper for businesses to borrow money to invest in their businesses.
Why, though, does nobody seem to mention the wealth-destruction side of an interest rate cut? When the interest rate on my conservative insured fixed income investments dips from 5% to 4%, my future income from that declines by 20%, and my wealth in such investments is reduced accordingly. Now if this is a time when my real estate has lost 20% of its value – say market value has dropped from $500,000 to $400,000 – and if I still owe $250,000 on the mortgage, my real estate equity has dropped by 40%, from $250,000 to $150,000. If I also have $300,000 in basically market-imitating mutual funds, and if the market has dropped 20%, I’ve lost another $60,000 in wealth there, and it’s now worth $240,000.
So before the Fed decides to do its thing, the real estate and equities part of my retirement nest egg has already dropped from $550,000 to $390,000 – a nasty, deep and frightening cut. And now, if I had $200,000 in CDs, etc., you’re going to knock the value of my fixed income investments down another $40 or $50,000?
Is it possible the reason for an economic slowdown may not be an excessive cost of money to borrowers? Could it instead be uncertainty over whether any investment will pan out, even at zero interest, because potential customers who would pay off the investment are scared silly from seeing the wealth they’ve built up over 35 years evaporate substantially in a few months? If the reason for stagnation is public anxiety over wealth contraction that already has struck both equities and real estate, why isn't it just adding fuel to the real fire by reducing the value of the fixed income portion? And as millions more American Baby Boomers face retirement and the need to tap their wealth for another 20, 30 or even 40 years, and want to weight the conservative fixed-income percentage of their total net worth more heavily, isn’t further reduction in its value a factor to be considered in whether the rate cut Wall Street wants is going to work as hoped or not?
I’m not an economist. Maybe I’ve just missed the answer to my questions in literature that flies way over my head. Just thought I would ask.
Why, though, does nobody seem to mention the wealth-destruction side of an interest rate cut? When the interest rate on my conservative insured fixed income investments dips from 5% to 4%, my future income from that declines by 20%, and my wealth in such investments is reduced accordingly. Now if this is a time when my real estate has lost 20% of its value – say market value has dropped from $500,000 to $400,000 – and if I still owe $250,000 on the mortgage, my real estate equity has dropped by 40%, from $250,000 to $150,000. If I also have $300,000 in basically market-imitating mutual funds, and if the market has dropped 20%, I’ve lost another $60,000 in wealth there, and it’s now worth $240,000.
So before the Fed decides to do its thing, the real estate and equities part of my retirement nest egg has already dropped from $550,000 to $390,000 – a nasty, deep and frightening cut. And now, if I had $200,000 in CDs, etc., you’re going to knock the value of my fixed income investments down another $40 or $50,000?
Is it possible the reason for an economic slowdown may not be an excessive cost of money to borrowers? Could it instead be uncertainty over whether any investment will pan out, even at zero interest, because potential customers who would pay off the investment are scared silly from seeing the wealth they’ve built up over 35 years evaporate substantially in a few months? If the reason for stagnation is public anxiety over wealth contraction that already has struck both equities and real estate, why isn't it just adding fuel to the real fire by reducing the value of the fixed income portion? And as millions more American Baby Boomers face retirement and the need to tap their wealth for another 20, 30 or even 40 years, and want to weight the conservative fixed-income percentage of their total net worth more heavily, isn’t further reduction in its value a factor to be considered in whether the rate cut Wall Street wants is going to work as hoped or not?
I’m not an economist. Maybe I’ve just missed the answer to my questions in literature that flies way over my head. Just thought I would ask.
posted by KISSWeb | 1:12 AM
3 Comments:
Can I leave a comment?
Ok, it looks like I can. By what mechanism does a 0.5% federal funds rate target lower your fixed income interest rate by 1% (from 5% to 4%)? From my limited observations, that hasn't happened in the past.
Oh, wow. You are right. I am wrong. The link b/w the rates is direct and consistent. Sorry I doubted you. Good point.
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