One of the key factors in why the Federal Reserve and indeed all central banks effectively ruin economies over the long term, is that they try so hard to counter basic human action. Take for instance, the interest rates.
An interest rate is a price on money. Or a price on time. You prefer $100,000 dollars now as opposed to later. Rather than wait and save up that $100,000 for free, you are paying for that time by way of an interest rate. From the other side of the fence, it’s the only reason anybody would lend money, there has to be something in it for them. Either way you look at it, it is a price and as a price it is subject to supply and demand.
In a truly free economy: If there are a lot of people who want to build homes, buy cars, etc. and require financing for it, demand will rise and, via supply and demand, interest rates will rise to meet the demand. Eventually the rates will reach a point where not as many people would like to borrow and the demand weakens. Again, via supply and demand, the interest rates will drop to meet the market.
When you have a central bank (which is what the Federal Reserve is, don’t let anyone fool you) that manipulates interest rates, you have a moral hazard. Because the Fed is influenced by the government and bankers who both desire cheap and easy money for their own interests, the Fed is pressured to keep the rates low and facilitate borrowing. The result is an over-supply of credit.
It’s like somebody selling ipods for three dollars instead of the usual $100. The same amount of people who would buy ipods at $100 are still going to buy them. Now, however, so are the people who will buy them at $90, $50, $10, etc. These people would not have bought them otherwise. Unfortunately, credit works a little differently than an ipod, because you have to pay it back.
When you have interest rate manipulation, you have the Fed forcing banks to sell (lend) credit at prices (interest rates) lower than they would like. Remember, there is always a demand at the right price. When prices are so low that everyone wants loans, the supply is going to run out. In other words the banks are going to run out of money to lend. To make a little bit more profit, the banks actually lend out more than they have in hopes that not too many of their customers will default and disrupt their cash-flow. I think we are all aware of how that kind of thinking turns out.
The point is banks, like all businesses, cannot function properly when their methods are being forced upon them. When they are told what price to sell loans at, they cannot run efficiently and crisis like the one we are experiencing now are inevitable.
Interest Rates are Prices
December 4, 2008
One of the key factors in why the Federal Reserve and indeed all central banks effectively ruin economies over the long term, is that they try so hard to counter basic human action. Take for instance, the interest rates.
An interest rate is a price on money. Or a price on time. You prefer $100,000 dollars now as opposed to later. Rather than wait and save up that $100,000 for free, you are paying for that time by way of an interest rate. From the other side of the fence, it’s the only reason anybody would lend money, there has to be something in it for them. Either way you look at it, it is a price and as a price it is subject to supply and demand.
In a truly free economy: If there are a lot of people who want to build homes, buy cars, etc. and require financing for it, demand will rise and, via supply and demand, interest rates will rise to meet the demand. Eventually the rates will reach a point where not as many people would like to borrow and the demand weakens. Again, via supply and demand, the interest rates will drop to meet the market.
When you have a central bank (which is what the Federal Reserve is, don’t let anyone fool you) that manipulates interest rates, you have a moral hazard. Because the Fed is influenced by the government and bankers who both desire cheap and easy money for their own interests, the Fed is pressured to keep the rates low and facilitate borrowing. The result is an over-supply of credit.
It’s like somebody selling ipods for three dollars instead of the usual $100. The same amount of people who would buy ipods at $100 are still going to buy them. Now, however, so are the people who will buy them at $90, $50, $10, etc. These people would not have bought them otherwise. Unfortunately, credit works a little differently than an ipod, because you have to pay it back.
When you have interest rate manipulation, you have the Fed forcing banks to sell (lend) credit at prices (interest rates) lower than they would like. Remember, there is always a demand at the right price. When prices are so low that everyone wants loans, the supply is going to run out. In other words the banks are going to run out of money to lend. To make a little bit more profit, the banks actually lend out more than they have in hopes that not too many of their customers will default and disrupt their cash-flow. I think we are all aware of how that kind of thinking turns out.
The point is banks, like all businesses, cannot function properly when their methods are being forced upon them. When they are told what price to sell loans at, they cannot run efficiently and crisis like the one we are experiencing now are inevitable.