Tuesday, August 5, 2008

Fed Rate Stays at 2%

In a move that seems to have gotten Wall Street excited, the Federal Reserve Bank holds overnight interest rates at 2%.

Judging from recent news stories, inflation fears seem to be subsiding, so pressure to increase rates is low at this point. Prices are already dropping in the asset classes (i.e. stocks and houses) and I predict will continue to fall throughout the general economy under supply and demand forces as we progress further into the current economic downturn. In time I anticipate wholesale deflation across the board.

Our financial industry is now subsidized by hundreds of billions of dollars of taxpayer-sponsored capital for banks and investment banks—in the form of TAFs, TSLFs, and PDCFs—at rock bottom interest rates disconnected, as best I can tell, from the Federal Funds Rate. But the low rate will keep adjustible rate mortgages low such that struggling homeowners can continue to struggle. Consequently, interest on capital supplied to banks (increasingly by government) has to be kept low. A low overnight rate also keeps interest rates on deposits low, so what savings are left in the system receive lower interest payments from banks.

The 2% interest rate no longer exists to entice more borrowing and consuming by the American public. Those days are gone. Interest rates are now suppressed to keep a flailing financial industry on life support. Wall Street's enthusiasm is misplaced.

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