Investors in the US woke up this morning to a rising US Dollar and falling gold prices. The reason is simple enough:
If a country is offering higher interest rates, and the perception is that the country’s economy is strong enough that payments can be made, lower-interest safe assets will be sold off and higher-paying (and probably higher-risk) investments will be bought.
The Fed’s two-pronged approach to the problems of 2008-9 are the reason why interest rates are currently rising. The 2 prongs are the Fed’s QE programs and the Fed’s setting of the base interest rate.
The Fed’s QE programs achieved their initial goal of floating the US through a shaky period. As warned by crusty old investors back then, the US markets found a way to funnel all that free money into profit-making things, like stocks. QE money didn’t really come from nowhere; it was created in the same way a mortgage by your local bank creates money.
Think back to your Econ 101 class, to that sunny Friday afternoon when you weren’t really paying attention, and the instructor droned through an explanation of Regulation Q. Which, in case you were really asleep, talks about how the base inter-bank lending rate relates to current balance. The explanation of how it works out always ends with “and is paid off by money actually made in the future”.
And until you pay the money back, you have to pay interest. Or in modern terms made popular by credit card programs, you only have to pay the monthly payment.
Every once in a while someone will ask this Gold Enthusiast – who is in the Curmudgeon phase and on the edge of attaining Old Codger status – why there is anything wrong with this approach? After all (the usually-young-and-innocent questioner asks) what’s wrong with just paying the monthly fee?
The problem is the same as why gold prices fell this morning. Interest rates.
You see, no one really knows what the future brings. You never know when a vote results in Donald Trump becoming President. (Just think – 2 years ago that would have been a good joke.) And you never know what interest rates are going to do.
When Ben Bernanke decided the QE programs were a good idea, interest rates were below long-term norms and sinking. Interest rates at that time meant the QE programs were affordable. To Curmudgeons and Old Codgers, and the few who’ve attained the coveted Really Old Curmudgeon status, the markets being below long-term norms was a Big Red Flag. Even a college freshman could predict with almost 100% certainty that interest rates would be higher in the future, as those monthly statements were rolling in. Some continue to say the QE programs were a bad idea from the start.
Which means the payments on the QE program would be larger in the future than they were back then.