Dear Mr. President, Be Careful What You Wish for: Higher Interest Rates Will Kill the Recovery

Higher interest rates will triple the interest on the federal debt to $830 billion annually by 2026, will hurt workers and young voters, and could bankrupt over 20% of US corporations, according to the IMF. The move is not necessary to counteract inflation and shows that the Fed is operating from the wrong model.

Responding to earlier presidential pressure, the Federal Reserve is expected to raise interest rates this week for the third time since November, from a fed funds target of 1% to 1.25%.  But as noted in The Guardian in a March 2017 article titled “Trump Is Set to Win the Battle on Interest Rates, but US Economy Will Pay the Price”:

An increase in the base rate, however small, will tighten the screw on younger voters and some of the poorest communities who voted for him and rely on credit to get by.

More importantly for his economic programme, higher interest rates in the US will act like a honeypot for foreign investors . . . . [S]ucking in foreign cash has a price and that is an expensive dollar and worsening trade balance. . . . It might undermine his call for the repatriation of factories to the rust-belt states if goods cost 10% or 20% more to export.

In its Global Financial Stability report in April, the International Monetary Fund issued another dire warning: projected interest rises could throw 22% of US corporations into default. As noted on Zero Hedge the same month, “perhaps it was this that Gary Cohn explained to Donald Trump ahead of the president’s recent interview with the WSJ in which he admitted that he suddenly prefers lower interest costs.”

But the Fed was undeterred and is going full steam ahead. Besides raising the fed funds rate to a target of 3.5% by 2020, it is planning to unwind its massive federal securities holdings beginning as early as September. Raising interest rates benefits financial institutions, due to a rise in interest on their excess reserves and net interest margins (the difference between what they charge and what they pay to depositors). But borrowing costs for everyone else will go up (rates on student loans are being raised in July), and the hardest hit will be the federal government itself. According to a report by Deloitte University Press republished in the Wall Street Journal in September 2016, the government’s interest bill is expected to triple, from $255 billion in 2016 to $830 billion in 2026.

The Fed returns the interest it receives to the Treasury after deducting its costs. That means that if, rather than dumping its federal securities onto the market, it were to use its quantitative easing tool to move the whole federal debt onto its own balance sheet, the government could save $830 billion in interest annually – nearly enough to fund the president’s trillion dollar infrastructure plan every year, without raising taxes or privatizing public assets.

That is not a pie-in-the-sky idea. Japan is actually doing it, without triggering inflation. As noted by fund manager Eric Lonergan in a February 2017 article, “The Bank of Japan is in the process of owning most of the outstanding government debt of Japan (it currently owns around 40%).” Forty percent of the US national debt would be $8 trillion, three times the amount of federal securities the Fed holds now as a result of quantitative easing. Yet the Bank of Japan, which is actually trying to generate some inflation, cannot get the CPI above 0.2 percent.

The Hazards of Operating on the Wrong Model

The Deloitte report asks:

Since the anticipated impact of higher interest rates is slower growth, the question becomes: why would the Fed purposely act to slow the economy? We see at least two reasons. First, the Fed needs to raise rates so that it has room to lower them when the next recession occurs. And second, by acting early, the Fed likely hopes to choke off inflationary pressure before it starts to build.

Rates need to be raised so that the recession this policy will trigger can be corrected by lowering them again – really? And what inflation? The Consumer Price Index has not even hit the Fed’s 2% target rate. Historically, when interest rates have been raised in periods of tepid growth, the result has been to trigger a recession. So why raise them? As observed in a June 2 editorial in The Financial Times titled “The Needless Urge for Higher Borrowing Costs”:

In this context, the apparent determination of the Fed in particular to press on with interest rate rises looks a little peculiar. Having created expectations that it was likely to tighten policy with three quarter-point increases over the course of 2017, the Fed is acting more like a party to a contract that feels the need to honour its terms, than a central bank that takes the data as it finds them. [Emphasis added.]

In the six months since President Trump was elected, the Fed has pressed on with two rate hikes and is proceeding with a third, evidently just because it said it would.  Impatient bond investors are complaining that it has found one excuse after another to postpone the “normalization” it promised when market conditions “stabilized;” and in his presidential campaign, Donald Trump attacked Janet Yellen personally for keeping rates low, putting her career in jeopardy. She has now gotten with the program, evidently to restore the Fed’s waning credibility and save her job. But the question is, why did the Fed promise these normalization measures in the first place? As then-Chairman Ben Bernanke explained its “exit strategy” in 2009:

At some point, . . . as economic recovery takes hold, we will need to tighten monetary policy to prevent the emergence of an inflation problem down the road. . . . [B]anks currently hold large amounts of excess reserves at the Federal Reserve. As the economy recovers, banks could find it profitable to be more aggressive in lending out their reserves, which in turn would produce faster growth in broader money and credit measures and, ultimately, lead to inflation pressures.

The Fed evidently believes that the central bank needs to tighten monetary policy (raise interest rates and sell its bond holdings back into the market) because the massive “excess reserves” held by the banks (currently ringing in at $2.2 trillion) will otherwise be lent into the economy, expanding the money supply and triggering hyperinflation. Which, as David Stockman puts it, shows just how clueless even the world’s most powerful central bankers can be in matters of banking and finance . . . .

Banks Don’t Lend Their Reserves

There need be no fear that banks will dump their excess reserves into the market and create “inflation pressures,” because banks don’t lend their reserves to their commercial borrowers. They don’t because they can’t. The only thing that can be done with money in a bank’s reserve account is to clear checks or lend reserves to another bank. Reserves never leave the reserve system, which is simply a clearing mechanism set up by the central bank to facilitate trade among banks. Technically, dollars leave the system when a depositor pulls money out of the bank in cash; but as soon the money is spent and redeposited, these Federal Reserve Notes go back into the banking system and again become reserves.

Not only do banks not lend their reserves commercially, but they do not lend their deposits. Banks create deposits when they make loans. As researchers at the Bank of England have acknowledged, 97 percent of the UK money supply is created in this way; and US figures are similar. Banks do not need reserves or deposits to make loans; and since they are now flooded with reserves, they have little incentive to pay interest on the deposits of “savers.” If they do not have sufficient incoming deposits at the end of the business day to balance their outgoing checks, they can borrow overnight in the fed funds market, where banks lend reserves to each other.

At least they used to do this. But since the Fed began paying Interest on Excess Reserves (IOER) in 2008, they have largely quit lending their reserves to each other. They are just pocketing the IOER. If they need funds, they can borrow more cheaply from the shadow banking system – the Federal Home Loan Banks (which are not eligible for IOER) or the repo market.

So why is the Fed paying interest on excess reserves? Because with the system awash in $2.2 trillion in reserves, it can no longer manipulate its target fed funds rate by making reserves more scarce, pushing up their price. So now the Fed raises the fed funds rate by raising the interest it pays on reserves, setting a floor on the rate at which banks are willing to lend to each other – since why lend for less when you can get 1.25% from the Fed?

That is the theory, but the practical effect has been to kill the fed funds market. The Fed has therefore implemented a new policy tool: it is “selling” (actually lending) its securities short-term in the “reverse repo” market. The effect is to drive up the banks’ cost of borrowing in that market; and when this cost is passed on to commercial borrowers, market rates are driven up.

Meanwhile,  the Fed is paying 1% (soon to be 1.25%) on $2.2 trillion in excess reserves. At 1%, that works out to $22 billion annually. At 1.25%, it’s $27.5 billion; and at 3.5% by 2020, it will be $77 billion, most of it going to Wall Street megabanks. This tab is ultimately picked up by the taxpayers, since the Fed returns its profits to the government after deducting its costs, and IOER is included in its costs. Among other possibilities, an extra $22 billion annually accruing to the federal government would be enough to end homelessness in the United States. Instead, it has become welfare for those Wall Street banks that largely own the New York Fed, the largest and most powerful of the twelve branches of the Federal Reserve.

Paying IOER is totally unnecessary to prevent inflation, as evidenced again by the case of Japan, where the Bank of Japan is actually trying to fan inflation and is now charging banks 0.1% rather than paying them on their excess reserves. Yet the inflation rate refuses to rise above 0.2%.  

Banks cannot lend their reserves commercially and do not need to be induced not to lend them. The Fed’s decision to raise rates by increasing IOER just increases public and private sector borrowing costs, slows the economy, threatens to bankrupt businesses and consumers, and gives another massive subsidy to Wall Street.

____________________

Ellen Brown is an attorney, founder of the Public Banking Institute, a Senior Fellow of the Democracy Collaborative, and author of twelve books including Web of Debt and The Public Bank Solution. She co-hosts a radio program on PRN.FM called “It’s Our Money.” Her 300+ blog articles are posted at EllenBrown.com.

46 Responses

  1. $2.2Trillion Dollars in the Banks “Reserves Account” at the FED? Why no use those reserves funds at the FED to reduce the National Debt? It was “free money” from the FED in the first place anyway for “Mortgage Backed Securities”(or, were they ‘Bad debts”?)
    And, maybe the government should place an annual levy on the Banks to pay down the National debt over the next few decades?
    The banks caused the current crisis. Let them pay to fix it.

    • Mr Harry: Exactly. Instead of rolling over all $5T of maturing publicly-held debt the next twelve months, retire $2.2T of it. Going forward, no more borrowing at interest by the Treasury. Let the Fed lend whatever the Treasury needs at 0% interest. And have the Fed similarly retire $200B annually of the publicly-held debt, rolling over the remaining $4.8T each year. In sixty years or so all the external debt is paid off, all we’re left with is debt we owe ourselves, and effectively interest free. The Fed will have morphed into a national public bank, and the Citibanks of the country will have slowly transitioned to only serving the commercial banking needs of the country. That should provide adequate earnings for them without fleecing the taxpayers and their progeny into eternity and beyond. Ha. Somebody have a better idea to pay off our national debt? I’m listening.

      • No argument from me Tom………

      • ?”Somebody have a better idea to pay off our national debt? I’m listening.”?
        How do you retire $2.2T of Treasuries without introducing $2.2T
        new “coined” money? ( Inflationary?).
        A better solution would be to Replace all maturing Treasuries with ZERO interest new Treasuries (a/k/a US Treasury Bearer Bonds).
        YOU NEVER HAVE TO “COIN” NEW MONEY unless they are redeemed.
        Read more….try to prove it wrong…or endorse for the betterment of all.
        IF ONLY….
        An Honest Central Bank
        *****************************
        ….. to be formed using PBI’s Public Bank System (51 public banks-50 states plus 1 for D.C. & territories)
        ….. combined with AMI’s “Separation of Private For Profit Banks (PFPB) from Government.
        there would be no need to raise interest rates.
        READ MORE:
        https://bestsolutionsfl.wordpress.com/…/where-we-went-wrong-in-god-we-trust-by-jus…

        • Treasuries are just corporate welfare. The Central bank doesn’t own them. They are investors’ deposits taken temporarily out of the economy, a monetary policy intervention. The interest they earn is a carrot, but taxpayers have no link to this operation. We could do with an honest central bank for sure and repeal the Glass Steagal repeal.
          I thought Clinton made a mistake with that but now I am convinced it really was deliberate. A GOP in Dem disguise!

  2. […] Ellen Brown Writer, Dandelion Salad The Web of Debt Blog June 11, […]

  3. When the Fed pays its profits, from seigniorage etc, into the Treasury it has effectively destroyed it. The Treasury is a sort of cemetery for government currency. Reason is that Treasury instructs the Fed to pay its debts in NEW currency. Taxpayers do not pick up any tab. Taxes received into Treasury are lost to the economy as well as are any profits. The government has no use for profits any more than it needs to borrow or save in its currency. It is the monopoly issuer of the dollar. It only uses newly created currency. Taxes do not fund federal spending. It makes no sense to say the interest on reserves could fund the homeless. Only politics stands in the way of addressing that, not the Fed.

    • It makes NO sense for the Government to be paying interest to a privately owned Bank, who have the job of issuing American dollars on the governments behalf. The funds are used for infrastructure spending that benefits ALL AMERICANS.
      And, while we’re at it, make BANKSTERS responsible for their illegal actions.

      • Come off it Brian! The Fed is NOT privately owned. It’s long been absorbed into the government. It’s influence is there because the board members are private bankers by profession. The fed does what its told by Treasury. The fed only pays bills as far as money creation is concerned and the funds stored there all belong to others. You could say the Federal government has no money [of its own]. It stores a lot of investors money as savings accounts. It pays interest [money from thin air] because it uses the money to tweak its monetary policy. It doesn’t spend it. It has no other need for used money, being the monopoly issuer of the currency.

        • You’ve got to be kidding…….

          • Most CERTAINLY NOT!

        • you know not of which you speak

          • If you can say that then your ignorance trumps mine. I don’t write anything I can’t back up. How about you back up your view?

  4. please keep up the great work ellen. i’ve been giving some of your articles to my local state senator. hopefully after passing the california single payer initiative she’ll help build a public state bank too.

  5. Lest we forget, raising interest rates is intended to slow the economy to prevent inflation. The economy doesn’t look to me like it’s in need of brakes nor is inflation a problem. The other impact of raising rates is that the dollar is strengthened, slowing exports, cheapening imports, thus hurting our balance of trade, causing further loss of jobs, loss of manufacturing technology growth, manufacturing skills, on and on and on.

  6. Thanks. For 7 months my states’ T bonds have over $1 million unrealized losses I suspect from Federal Reserve policy to raise rates by selling bonds which lowers T bond prices. Maine should send them a bill for money lost.

    In the end this policy would fail to raise rates and even if it did it would fail to reverse inflation. It will more likely deflate the dollar.

  7. Why can’t the US Treasury issue American dollars, and cut out the “middlemen”?

    • Because then the Zionists who own USSA wouldn’t get their cut. You people just don’t get it. It’s the height of naivety to assume that things are actually done in the country’s best interest. We’re just a host for the bloodsucking parasites.

      • I’m(and the other commenters I’m sure) not naïve. We know how it works and who benefits. The system(like a casino) is rigged in favour of the “owners”…….

  8. Good!
    Survival of the fittest, not the fattest.

  9. What recovery? Isn’t it time we stop penalizing savers in this country?

  10. Why the FEDS must raise rates.
    97% of the money in circulation is Private For Profit Bank created
    “out of thin air” and If not returned “to thin air” will drive ‘good money out of circulation’ (Gresham’s Law).
    In 2008, US stock value was $47.2 Trillion.
    There is but one method to prevent a bust:
    Two steps.
    1/ Raise rates making it difficult for PFPB to make loans (read create money).
    2/ Raise margin requirements (get more good money in).
    There is no other way to prevent a ‘credit money creation from Boom to Bust. Period.
    As for the increase in Treasury debt service, there is no problem for US owned Treasuries because it is only placing new money (our own debt) into circulation by the Central Bank; however, when the Treasury is owned by another sovereign nation, this new money creates a new debt
    for our sovereignty (read must be paid).
    Perhaps, maybe there should be a rule.
    All Foreign owned US Treasuries either be at ZERO interest
    or be converted into NON-INTEREST Bearer Bonds.
    IF ONLY….
    An Honest Central Bank
    *****************************
    ….. to be formed using PBI’s Public Bank System (51 public banks-50 states plus 1 for D.C. & territories)
    ….. combined with AMI’s “Separation of Private For Profit Banks (PFPB) from Government.
    there would be no need to raise interest rates.
    READ MORE:
    https://bestsolutionsfl.wordpress.com/…/where-we-went-wrong-in-god-we-trust-by-jus…

    • Absolutely….raise rates and watch the fake and rigged system deflate. It would be beautiful. Swapping Fed reserve notes with Treasury notes slowly over time would prevent a catastrophe. Trump, wake up man!

  11. As it should kill the fake recovery and get on with the deflationary pressures in the system. Why try and fight what is right in a free market capitalist system? Keynes was a fool and so is the Fed. Demand higher interest rates, and watch lower asset prices and a stronger currency, higher standard of living unfold your before your eyes, ….before it’s too late.

  12. Though I always agree with everything that Ellen writes, there is one thing she is not including in her current essay; the non-existent interest on retirement savings that have also been suffering terribly under the current near zero interest rates.

    The fact that the Fed will increase interest rates slightly is not a call for alarm but in some respects will ease the choke-hold that investments have been under for many years while releasing some monies for spending into the economy.

    Yes, a slight increase may hurt younger voters by increasing prices on such items as housing, college loans, cars and the like. However, let us put some of this in perspective. Housing in many cases is currently out of the reach for many prospective home-owners. And many young people purchase houses at exorbitant cost to themselves placing their futures in financial jeopardy. It is the same for university where may students incur major debts on college education they could more reasonably get at local community colleges and state universities. Car leasing for small cars has become very popular over purchasing and the pricing for many such vehicles is aimed at young drivers making costs somewhat affordable.

    True keeping interest rates low may benefit certain aspects of the economy but it is also hurting other sectors at the same time. And battling inflation as Ellen suggests the Fed is doing has been a red-herring for many years.

    The problem with the entire mess is that the Fed is not a Public Bank allowing for the government to easily borrow from itself. Instead, it is a privater organization that runs the commercial banking system for its own benefit, which subordinates the government to its own whims (what the Fed does is not quality economics by any stretch of the imagination),.

    Instead of looking at this issue from a single issue perspective, the priority should be to eliminate the Fed altogether and return its operations to the Treasury Department while creating a Public Bank for the United States. Complaining, writing about such issues and anything else is a waste of time and effort…

    • “the priority should be to eliminate the Fed altogether and return its operations to the Treasury Department”

      That’s what President Kennedy intended to do, and he got three bullets through the brain for it. Bobby Kennedy was ‘like minded’ and he was ‘eliminated’ as well. I believe the same group of people were responsible for 9/11 as well. They ‘own’ America, and they’ll never give it up, unless forced to.

      • Can’t vouch for all that, Mr Harry, but I certainly agree that any president that tries to get the Big Banks out of the government debt trough better have the round ones that Andrew Jackson had. Dealing with the current Russian McCarthy-class conspiracy is child’s play in comparison.

  13. […] Dear Mr. President, Be Careful What You Wish for: Higher Interest Rates Will Kill the Recovery […]

  14. […] Full Article: Dear Mr. President, Be Careful What You Wish for: Higher Interest Rates Will Kill the Recovery […]

  15. What recovery?

  16. It seems that most of us could use some basic education about how the banks work. There is a small book on Amazon kindle “Before we hit the streets’ y Izabela Litwin.

    • Ellen’s book “Web of Debt”; “The Creature From Jekyll Island”, by G. Edward Griffin; “The Secrets of the Temple”, Wm Greider; Ellen’s “The Public Banking Solution”. After those four books, Joanna, you’ll be a different woman. I guarantee it. Should be required readings for every high school student and college student in America. Of course, if we start down that road, BofA, Chase, et al will burn all those books. Can’t win, probably.

  17. Good grief, Ellen, you do understand that taxes pay for nothing whatsoever in a country sovereign in its currency, and that interest paid is done with computer strokes, not by having to produce anything for sale. The US is the issuer of its currency, not a user of it like the various states or like private entities.

    • Is the USA sovereign in its currency? Whom does the Fed obey? Not any other part of the US govt. That’s what Greenspan said.

      • The Fed obeys Treasury. Treasury says what to buy etc and the fed credits customer accounts held by commercial banks at the fed. It’s a net credit operation and is how currency enters the economy.
        Don’t be fooled. Taxes can only be paid AFTER the fed has put money into the economy. Spending comes first but always buys a debt.

        • “The Fed obeys Treasury.” Do you have any credible cites for that? I doubt that it is true. It is the opposite of what Greenspan said. Maybe the Fed obeys the Treasury something like MacDonalds obeys me when I go in and order a hamburger. That doesn’t mean I have anything to say about how MacDonalds is run or what decisions it makes. The Fed does not even allow itself to be audited.

          • “The Fed does not even allow itself to be audited”.
            A financial enterprise that doesn’t get audited?….Sounds like the perfect crime to me…..

            • Indeed. It wouldn’t be the only criminal “govt. agency.” The CIA is famous for its drug business. Michael Collins Piper in Final Judgement said that the CIA is so intertwined with the Mossad that they’re almost the same agency. When the head of the Bank of Israel, Fischer, is shifted over and becomes vice head of the Fed it makes you wonder. Financial guru Marc Faber said that Goldman Sachs IS Israel. Maybe the Fed “is” Israel too. Anyway, economic theory about what a sovereign govt. can do aside, to what extent the US govt. is sovereign questionable.

              • I don’t know why the USA Government and the People put up with Israel’s ‘strangle hold’ on the USA…..Is there NO ONE who can clearly see the danger the USA is in?

                • I think it’s partly because so many Christians think Israel should be supported. You can’t fix stupid. That and the fact that people are so heavily propagandized and brainwashed.

                • Harry, I would say that’s a notion too far. Many people can’t handle it, but I believe America’s become the chosen people by virtue of association. Maybe not, but I’m not for risking it. Ha.

                  • I think belief in “choseness” and exceptionalism–thinking you are above the law–are intrinsically very bad.

          • I can’t quote the source as I didn’t copy it, but possibly it was in “Billyblog” [Bill Mitchell] eminent MMT savvy professor. Anyway by definition alone Treasury manages government spending. The Fed with it’s FOMC sets interest rates and actually sends money to government creditors who all have reserve accounts there. The Fed has NO money of it’s own. It’s all money from the non government sector there.

            • “The Fed has NO money of it’s own. It’s all money from the non government sector there.” I don’t buy that statement. The Fed has a printing press (not literally, but in effect) and produces at will, as in 2008, to give to its buddies, all in the darkness of secrecy.

              • It doesn’t change the fact because you don’t buy it. It certainly produces payments at will. Apparently the real total of the GFC payments was $29TRILLION between 2008 and 2010. Every dollar that enters the economy is created by the Fed’s spending. Even bank money comes from the government approval to cash out its credit creation liabilities.
                Every dollar the Fed creates is paid into commercial bank accounts simply by marking up the numbers.

  18. […] Dear Mr. President, Be Careful What You Wish for: Higher Interest Rates Will Kill the Recovery Posted on June 11, 2017 by Ellen Brown, […]

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