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Boom time

Don't be alarmed by rising interest rates; they reflect economic strength and demand for capital



Fed raised interest rates Interest rates can rise too high. At the close of the Carter Administration we were looking at rates as high as 17 percent. That puts capital out of reach for too many people, and makes the risks associated with taking on debt too great in most cases. But interest rates can also be too low. Ever since the market crisis of 2008, the Federal Reserve has kept interest rates lower than they probably should have been, because the Fed thinks its job is not just to maintain the stability of the currency (which is its real job), but also to control inflation and battle unemployment. The longer we experienced muted economic growth under Barack Obama's high-tax, high-regulatory, anti-growth policies, the longer the Fed felt the need to keep interest rates low. The result of this was that interest rates didn't really reflect the true demand for credit, and the cost of the federal government's deficit spending was made to look lower than it probably should be.
So when the Fed raised interest rates last week for the third time this year, and indicated it will probably do likewise next year, a lot of people saw this as a bad thing. How can high interest rates be good? But there are a lot of ways they can be good. During the Obama Administration, federal regulators beat up banks who tried to lend money outside the parameters preferred by Washington. As a result, most banks accumulated far more capital reserves than are required by banking laws. That means they have a lot of unproductive money sitting in their coffers - money that could be lent out to spur further economic activity. As the economy grows, we will see more demand from both individuals and businesses to borrow that money and use it in various ways. To buy homes and cars. To build and grow businesses. When there's more demand for capital, a higher interest rate is Economics 101. Banks can charge more for the money they're lending because people are more motivated to borrow it. Also, in a growing economy, the borrowers are more likely to be able to handle the higher debt service costs. That protects the health of the financial sector, and if you don't understand why that's important, I'll refer you back again to what happened to the banks in 2008. We need strong healthy banks, and the ability to charge interest rates that reflect the market is part of how they stay healthy. By the way, higher interest rates also benefit savers. When there's more demand for lending capital, banks need more deposits, and they're willing to pay you more to put your money on deposit with them. Now of course, if the economy that's primarily driven by debt-financed activity, then everyone saddled with debt is paying more when interest rates are high. But that's also one of the reasons you want to keep interest rates high. You don't want too many people going into too much debt, and if interest rates are artificially low, then it's too easy for that to happen. The main thing to understand is that economic activity is picking up, and that's what's driving the rise in interest rates. Retail activity has turned out much stronger this holiday season than economists were predicting. Jobless claims are down. Business investment is up. And a tax cut is coming within days. The first year of the Trump Administration has not produced everything we wanted, but the overall economic performance has been triumphant, and we're just getting started. That's why interest rates are rising, and that's why you should understand it's very good news.

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