Sunday, October 7, 2018

The perils of rising interest rates

The fertilizer hits the ventilator at 3.5%. That is when we will see who is swimming naked.
Most of us understand the issues around high interest rates. Given a choice between a credit card with low interest rates and one with higher rates, nearly everybody will choose the lower rate card. The reason is simple, lower rates leave more money in your pocket.

In the larger scheme of things, rising interest rates expose fraudulent business plans. It seems pretty basic. One would think the primary reason for running a business is to make a profit. That is, combine inputs: Labor, materials, rent, design, capital in such a way that the final result will command more money in the free market place than the cost of the individual components.

Sadly, this is not always so. Some "businesses" exist to harvest government incentives, including subsidized interest rates.

Rising interest rates expose these fraudulent businesses, i.e., malinvestments.

Skipping a lot of boring details of finance, the resulting vaporization of "value" when these malinvestments are uncovered results in banks being unable to lend money because they must retain funds to repair their balance sheets.

Even healthy businesses depend on access to credit to exploit opportunities or bridge liquidity hiccups. Immolation of fraudelent businesses due to rising interest rates damage healthy businesses because banks cannot lend funds they do not have. The math of the fractional banking system means that the destruction of every dollar sucks $5-to-$10 out of the economy.

A word to the wise: It never hurts to scrape the barnacles, trim the sail, batten the hatches and bank the fires. In other words, consider selling your "toys" especially if you borrowed money to buy them. If you have friends or family who count on you for economic out-patient-care, this is a good time to tell them to get a job and to cut their costs so they are less of a drag on you.

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