I'm always dumbfounded by the amount of wasted energy expended by individuals and institutions attempting to second-guess future economic events. And compounding the fruitlessness is the further attempt to determine how those economic changes will impact financial assets. What a waste of time. The best “night-guard” for all the teeth-gnashing is simply to diversify investments and sit tight come what may.
That said, the news media is obsessed with the Federal Reserve and its threat to raise interest rates by one quarter of one percent. The daily fluctuations in the stock market seem to hinge almost totally on some collective reading of tea leaves that promises advance warning of the Fed’s next move.
In theory, the most influential component prompting a rise in interest rates is the unemployment figure and the fear of rampant inflation that follows full employment. The theory is that when unemployment goes down, the demand for labor is higher because the supply is lower and people get paid more as a result which increases costs --- and, by extension, prices go up. Unfortunately for “big picture” (macro) economists, it’s not that simple.
Some people are calling on the Fed to raise interest rates to “return markets to some semblance of normalcy” according to a report on Bloomberg Go. If you believe that inflation is still tied to low unemployment, then the problem becomes one of determining which inflation and unemployment figures you want to use. There are several variations of each.
Other factors influence inflation a lot. Productivity growth facilitated by, for example, the proliferation of the internet, clearly helps to suppress what would be the rising prices of both services and products. Food prices and energy costs have been dropping dramatically which also contributes to low inflation rates.
For all the talk of middle class incomes that have been stagnant for years on an inflation-adjusted basis, there has been little mention of the flip side which is the benefit of historically low interest rates. In normal times, for example, over the length of a five-year car loan at, say, 10 percent, the interest cost worked out to be one-third to half of what the car cost. Over three years back in 1969, I paid $1,400 in total interest on a new Chevy that cost $3,000 at the time. It was my first wake-up call about what interest can add up to. By comparison, today’s total interest on new cars amounts to about 10 percent of the cost. Factor in the low rates on home mortgages, reduced prices on fuel and the reduced prices that reflect lower commodities costs.
As if low prices weren’t enough, the stock market has benefited substantially from the level of consumer spending and low corporate borrowing rates. IBM recently borrowed several billion dollars at 1.5 percent interest. The same loan years ago would have involved arithmetic similar to that of my first car loan. Meanwhile, most middle income families today have at least some money in the stock market through various retirement plans and IRA’s. To the extent that this represents the beginning of long-term financial security, it could actually be more valuable than what might have been an incremental increase in inflation-adjusted income.
In short, we are a country of 320 million people working hard and creating $17 trillion worth of Gross National Product. What the Federal Reserve does or doesn’t do in the face of this steamroller is nothing more than financial theater.
Correction: In a column back on April 30th on estate taxes, I incorrectly stated that while the estate tax had dropped to zero in 2010, the heirs were deprived of a stepped-up cost basis. They were stuck having to pay capital gains taxes based upon the original price paid for the asset by their parents or benefactors. In December of 2010, Congress passed a law at the last minute that gave people a choice. They could pay the new 2001estate tax rate and get the stepped up basis or they could avoid the estate tax and be stuck with having to pay capital gains taxes when they eventually sold the asset.