The Downside of Low Interest Rates

Low interest rates have fueled our economy and stock markets for quite some time, and the Federal Reserve (Fed) says we will have them for the foreseeable future. Investors are excited about that. After all, who doesn’t love low interest rates? Few people get through life without taking out loans. Houses, automobiles, education, starting a business and other big-ticket items can be difficult to pay for without borrowing.

Companies also love cheap credit. Businesses run daily operations, pay for inventory and plan future growth on borrowed money. Low rates mean they can do more of it. And let’s not forget the federal government with its voracious financial appetite. Even the slightest movement in interest rates can affect the federal budget by tens of billions of dollars. Certainly, politicians love low rates. Is it any wonder that in this environment the federal government spent $3.1 Trillion more in 2020 than it took in, and is on track to dwarf that number in 2021?

Though an abundance of cheap money can seem like a great thing, unusually low interest rates are not all good news. Retired individuals or other savers who are looking to reduce risk in their portfolio have been hurt in recent years with low rates that don’t even keep up with inflation. Large institutions that for legal or practical purposes keep significant funds in interest bearing accounts have also been affected. When I was a younger advisor there were many safe, interest-bearing options that paid good returns but those have largely disappeared.

Low rates discourage saving, weakening many business and family financial positions while also reducing funds available for future needs. Higher interest rates on the other hand encourage saving and discourage excessive borrowing. It’s good to have a healthy balance but it seems we have forgotten about the savers while becoming a nation of spenders and borrowers.

Apart from tempting people (and governments) to borrow more than they should, low interest rates have an inflationary effect by creating higher demand. Take a look at the current housing market with its sky-high prices, driven largely by extremely low mortgage rates.

Though I love low interest rates as much as anyone, it is my belief that they need to go up a bit in order for our economy and our people to be more financially healthy. When they do so, economic growth will temporarily slow down, but at the same time it will help provide a firmer foundation on which to build our personal and national future.

​Investors can ride the wave while rates are extremely low, but when they start moving up, try to see it as a good thing from a long-term perspective. I think it would benefit all of us to borrow a little less and get rewarded for saving a little more.