Traditionally, manufacturers have been taught that rising interest rates are bad for business for two reasons. First, higher rates make it more expensive for consumers to borrow money or use their credit cards to purchase things like houses, automobiles and appliances. Second, rising rates are usually accompanied by a rising value of the dollar.
You don't have to be an economist to understand that these two outcomes tend to create negative results for manufacturers.
But I have come to believe that things are different this year. And though I reserve the right to change my mind, I think that rising interest rates in the coming months will ultimately be good for the U.S. economy and U.S manufacturers. The case for this is nuanced, but I will try to explain.
Changes in interest rates are the mechanism by which the market assesses risk. Most of the time, we tend to think of risk in terms of the default risk. The future is inherently uncertain; therefore, there is a chance that a lender may not get all of his money back. So a borrower pays interest to offset this risk.
But at the present time, there are a couple of other risks that must be considered. One of these is the risk of inflation. The other is the risk of losing an opportunity to make a higher rate of return with your money if economic conditions improve.
Right at this moment, the rate of interest an investor can get by purchasing a five-year Treasury note is almost 2 percent. We know that if you purchase these notes, you have negligible default risk, so there is no worry there.
But when you consider the fact that the long-term rate of inflation that policymakers are striving hard to achieve is also 2 percent, such a return for tying up your money for five years is not so good — unless you are expecting a recession in the near future. For the record, I am not expecting a recession anytime soon.
Or, to put it another way, if you deposit your funds in a bank, you will receive an interest rate below 1 percent. At this rate, your purchasing power will gradually diminish over time due to inflation (even though the inflation rate is low right now, it is higher than 1 percent). The bank can lend your money out, but the rate of interest it receives at the present time is also low, so they have not been able to generate strong profits. When you add in the amount of paperwork and other regulatory risks that banks incur, you have a situation where banks are struggling to make a profit.
In short, savers are not happy and banks are not happy. Now I know that it was the banks that almost blew up the economy nine years ago. They got greedy, and so did many consumers. But maybe we need to realize that if this is a good time for banks to make money, it is a good time for all of us to make money.
For the past eight years, prevailing interest rates have stayed in a low range that most of us never experienced before. They have been well below what any reasonable person would describe as normal. Yet the overall economic growth, and the growth in the demand for capital, and the growth in demand for consumer loans, were all less than desirable.