Money Advice Guide

First, what interest rates are we talking about and why is it important to both the economy and business decisions?

There is an old saying that money makes the world go around. In economic parlance this is not quite correct. Actually, it is the cost of money that makes the world go around, and this cost of money is reflected in the level of interest rates. As the level of interest rates rise, businesspeople and investors demand a higher rate-of-return on their capital investment to justify the expenditure. The result is similar to “walking up a pyramid” in that fewer and fewer capital expenditures can justify the targeted rate-of-return. As productive investment decreases, so does the speed at which money circulates (its velocity). With some lag time the economy begins to slow and unemployment starts to increase.

With such importance attached to interest rates, does the Federal Reserve Board (FED) really control their level? To simplify, we must differentiate between short-term and long-term rates. Interest rates on securities that mature in less than a year would be considered short-term, while interest rates on securities that mature in over 10 years would denote long-term rates.

The FED through its open market policies does have a powerful impact on short-term interest rates, namely the federal funds rate and its brother, the three-month Treasury bill rate. The federal funds rate is an overnight rate at which banks lend to each other.

Long-term interest rates, however, are set more by the market than by the FED. These rates reflect peoples’ expectations of economic growth, both real and inflationary. When a businessman issues a 20-year bond yielding 10% interest per year, he is assuming the funds can be profitably invested in an enterprise earning significantly better than 10%. If this isn’t so, why borrow the money at 10%?

The movement of interest rates can give us a clue as to the future direction of the economy. It is not the absolute level of short-term or long-term rates that is important–it is the spread between them. For example, if long-term Treasury bonds are yielding 5% and the 90-day Treasury bills are yielding 2%, then the spread is three percentage points.

As the FED tightens-up on the money supply, short-term rates will climb faster than long-term rates. If short-term interest rates start to climb above long-term rates (as happened in l979, l980, l981, and in year 2000), this is an early warning sign that the economy will be slowing significantly–possibly entering a business recession.

As this happens, it would be best to reduce your short-term debt levels and start to rebuild liquidity. Business slowdowns or recessions can be times of great opportunities, but only for those who have the resources. The future belongs to the swift–Liquidity is King!

Tags: business, economic trends, economy, federal reserve, finance, interest rates, management, small businessbusiness, economic trends, economy, federal reserve, finance, interest rates, management, small business

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“Twas brillig, and the slithy toves Did gyre and gimble in the wabe; All mimsy were the borogoves, And the mome raths outgrabe.” Reading silently or aloud creates rhythmic nonsense, you might think. Humpty Dumpty explains, defines, and clarifies for Alice. Soon Alice sees meaning. As she does, the upside downs become the right side ups.

Alan Greenspan often sounds like the Jabberwocky as much as Humpty Dumpty seems senatorial. Mr Greenspan’s econoblab explained a lot without telling much. His Federal Reserve messages provide detailed economic data with vague nuanced economic outlook. Many Federal Reserve watchers hope Mr. Bernanke (Alan Greenspan’s successor) tells us a lot so that senatorial Humpty Dumpty’s do not seek explanations for economics “…that haven’t been invented just yet.”

When the Federal Reserve Chairman presents the “Semiannual Monetary Policy Report to the Congress”, it is called the Chairman’s testimony. Testimony may be defined as “Evidence in support of a fact or assertion; proof.” Statements must be lucid and transparent to the hearers to prove assertions or claims.

Mr. Bernanke seems to do this with greater clarity. His sentences are brief, but not terse. According to a CNN Money.com poll, most respondents consider Ben Bernanke’s testimony (or shall we spell it “testimoney”?) the “Same as Alan Greenspan”. If transparency and clarity mean something, it is time for Mr. Bernanke to “explain” it to us.

* The new Fed Chairman used these phrases: “The U.S. economy performed impressively in 2005.”

* “…Energy prices rose substantially yet again.”

* “The Gulf Coast region suffered through severe hurricanes that inflicted a terrible loss of life”

* “Inflation pressures increased in 2005″

A friend calls these “keen observations of the obvious.”

We should expect more from the Fed Chairman. Investors need to know if rates will go up rather than guess. Ratcheting interest rates slows the housing market (Greenspan mentioned this “bubble”), increases the cost of debt as credit card companies and mortgage companies leverage rates, and sends equity and bond markets into an economic whirlpool.

Rate increases may control inflation, but they do little or nothing, in my opinion, to encourage an economy. There is a greater likelihood that the Fed will overdue interest rate increases (up or down). This will push the economy into a recession or a bubbling boom.

Residents of econoland, known as economists, worry that the Fed will overdo their inflation concerns. According to some, the Fed has managed inflation poorly since World War II. Nothing in this Federal Reserve Chairman’s testimony suggests otherwise.

Does the Fed move rates up or down, or do interest rates adjust coincident with inflation reports and other economic data? Watch the market before and after the Consumer Price Index reports. The January CPI shows a .7% inflation increase with 70% of that increase attributed to energy costs. You would expect the market to collapse on such news; it did not.

The markets go up sometimes and down others. Humpty Dumpty, would you make the upside downs become the right side ups?

“`Of all the unsatisfactory–’ (she (Alice) repeated this aloud, as it was a great comfort to have such a long word to say) `of all the unsatisfactory people I EVER met–’ She never finished the sentence, for at this moment a heavy crash shook the forest from end to end.”

Ray Randall serves clients as a registered investment advisor with his firm, Ethos Advisory Services, Essex, Massachusetts Ethos Advisory Services. He has wide experience within the financial services industry, writes a weekly newsletter for http://www.ethosadvisory.com Ethos Advisory Services, and coordinates the developments at http://www.echievements.com Echievements.com. Ray holds a Masters Degree from Gordon-Conwell Theological Seminary, Hamilton, MA. You may call Ray (617-275-5565).

Tags: Credit Card Rates, federal reserve, interest rates, mortgage ratesCredit Card Rates, federal reserve, interest rates, mortgage rates

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