What if US had raised interest rates?

At the end of 2015, the US national debt will be 18.6 trillion dollars. With such a big number, it’s tempting to put it in perspective by comparing it with things more easily envisioned. Alas, I can not think of anything that puts such an oppressive and unfair burden into 98e2c31e5c194d21be9fd3922dc45fde9207f454perspective, except to this:

US debt represents a personal obligation of $60,000 for each American citizen. And it is rising quickly. Most of our GDP is used simply to pay down interest on that debt. Few pundits see a way out of this hole.

In my opinion, that hole was facilitated in August bretton_woods-a1971, when the US modified the Bretton Woods Agreement and unilaterally terminated convertibility of the US dollar to gold. By forcibly swapping every dollar in every pocket and bank account with the promise of transient legislators, individual wealth was suddenly based on fiat instead of something tangible or intrinsic.

Feds Meet: No interest rate hike

The benchmark interest rate set by the US Federal Reserve Board is currently between 0 and 0.25%. It has been at or near zero since 2006.

By now, most Wild Ducks know that 20 hours ago, the US Federal Reserve board decided to not hike the benchmark interest rate. The Fed did, however, signal that they still intend to raise interest rates at a future meeting—perhaps in October or December.

The announcement came just after US equity markets closed. But, in what has become a most odd news coverage of a non-event, the immediate reaction was to lift the Asian stock markets, which were still open during the announcement.

I am a frequent contributor to Quora. I field many questions on economics, politics, law, and even physics. You might be inclined to check out my credentials as pundit of macro-economics. Don’t bother…There are none! I am an armchair economist (this is the same as saying: “I am not an economist”). But I certainly follow these things closely, and have an opinion.

Today, I was asked this:
What would happen if the fed had raised interest rates?

The question asked specifically about the effect on other interest rates, but a more interesting exercise might be to speculate on the state of the economy. Here then, is a Wild Duck response…

If we could freeze all other conditions and avoid the effects of public confidence, likely change in debt, debt rating, etc… If  we ignore these things, then the direct result of raising the interest rate for a given national currency is to attract outside money. That is, we would see an increase in foreign conversion into dollars and a movement of US assets from stocks and bonds into currency or currency equivalents. This is a simple result of the higher payout that one would expect after a raise in interest rates.

In theory, the sift of international assets and investment into dollars does four things:

  • It strengthens the value of the dollar, thereby increasing the take-home potential of US workers and the number of things US residence buy from overseas (because a slightly higher fraction of organizations seek dollars)
  • It increases income for anyone tied to published interest rates, such as many senior citizens.
  • It increases interest payments from anyone tied to published interest rates. For anyone deep in debt on instruments such as credit cards or home equity, this can have a devastating impact—causing minimum payments to rise by many times the interest rate hike.
  • It increases US national debt, because so much of the economy is built on forward loans in the form of Treasury notes. With an interest rate increase, the US must pay more on both new debt and the financing of massive outstanding debts.

This is all theoretical, of course. In practice, one of the first effects is for individuals and institutions to wonder: How can the US possibly pay out on debt at an increased rate?”.  [possible answer]*

One very obvious effect is that many individuals will further lose confidence in the American economy or the will of Americans to honor the national debt. Because of this, the effect of raising the interest rate (for the first time in 9 years) is not easy to predict. Despite massive uptake on US debt, the Chinese and energy producing nations have limits to what they can believe. A subtle switch in their investment activity (or the determination to move away from a dollar-based reserve) will have massive repercussions, especially for the US.

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* Some pundits argue that US debt—and the massive interest payments and trade imbalance that feed it—can continue to grow. They argue that confidence in fiat currency is protected in these ways:

  • a recovering economy
  • increased activity from the new investors
  • need for producer nations to seize on a massive consumer market
  • need for producer nations to invest their gains

But, a growing number of economists, investors, analysts, credit bureaus, and citizens don’t buy this argument. They recognize a pyramid scheme. At best, it kicks-the-can down the road and foists untenable debt on future generations. They would prefer that the US reign in spending and pay down debt.

In this regard, hosting the world’s reserve currency has helped to hook the US on debt, and it has ballooned out of control. Transitioning to a firmly capped currency that is not controlled by legislation or a reserve board would help the country avoid a confidence crisis and a debt that pushes bond buyers to look elsewhere. It is high time for our leaders to do what they must do.

In my take, the real question is not “What if the Fed has raised interest rates?” The real question is:

Does the U.S. have the courage to link its currency to something durable
— and beyond control of transient political winds and a debt pyramid?”

Sure, we must still honor the excess of the past 40 years. But with gold, or Bitcoin, at least we will have solid underpinnings and incentives to spend within our means.

Ellery Davies is a member the New Money Systems Board
at Lifeboat.org. He is Co-chair of Cryptocurrency Standards
Association and  editor at A Wild Duck.

One thought on “What if US had raised interest rates?

  1. Ellery,

    The two charts, particularly the second chart, in the linked article below

    http://www.theatlantic.com/politics/archive/2011/07/the-chart-that-should-accompany-all-discussions-of-the-debt-ceiling/242484/

    show that MOST of the federal budget deficit is due to the Bush Tax cuts and Iraq/Afghanistan wars, with the tax cuts being the primary contributor by far. Pre Bush tax cut would be the Clinton tax rates, which were only moderately higher than the rates Reagan left us with. The first President Bush and Clinton raised taxes, but we still had a sustained economic boom in the 1990’s and finished the decade having reversed the Reagan budget deficit to a SURPLUS. George Bush II brought back the deficit and exploded the debt. (The charts don’t show it, but most of the cost of wars is Iraq, not Afghanistan.) The revenue lost from the Bush tax cuts alone would have paid for both wars several times over (dark orange vs. light orange in second chart) and caused over HALF of the deficit. The huge annual deficits added to the debt each year.

    So the current problem is not the remaining spending(non-Iraq/non-Afghanistan), 75% of which is Defense, Health Care(Medicare/Medicaid) and Pensions (Social Security). (See link below.) The Medicare and Social Security are self funded with their own payroll tax.

    Federal Spending pie chart
    http://www.usgovernmentspending.com/federal_budget_pie

    The Bush tax cuts really just redistributed wealth. A full 38% of the cuts went to the top 1%. (See link below.) Even before the tax cuts, the top 1% were doing just fine. So were the lower 99%.

    http://www.epi.org/publication/the_bush_tax_cuts_disproportionately_benefitted_the_wealthy/

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