I have been teaching Corporate Finance I, the introductory Finance course at Ramapo College’s business school, since 1985. In the textbook’s chapter on interest rates, which is a standard discussion in all textbooks, students learn that the following equation, r = r* + IP. In other words, the nominal interest, rate, r, the rate earned on risk-free debt (such as three month U.S. Treasury bills) equals the real rate of interest (the rate mutually agreed upon by borrowers and lenders in a free market) plus an inflation premium. (For non-risk free debt there are additional premiums, liquidity, default, etc.)
Introductory finance textbooks use 2% as the real rate. Some may even use 3%. Nevertheless, the inflation premium is usually estimated to be the latest annual increase in the Consumer Price Index (CPI). For the past 12 months the CPI increased 2%. So if we substitute these numbers in the equation, savers should be getting approximately 4% on their savings accounts and money market accounts. Instead, the American people are getting no more than 1%. The one-year T-bill rate is currently yielding .13 percent, virtually nothing, when it should be yielding about 4 percent. (See www.money-rates.com for a rundown of interest rates banks and money funds are offering savers.)
Why is this happening? For the past five years, the Federal Reserve, which has the legal authority to create money “out of thin air,” has flooded the financial system with more than $2 trillion of new money; the primary effect of so-called quantitative easing has been to drive down all interest rates, including short-term rates to almost zero.
How long will the American people allow their savings’ returns to be looted in the name of monetary “stimulus”? With the recent Cyprus bank closings and the confiscation of large depositors’ funds by the government to shore up the shaky fractional reserve banking system (see Joe Salerno’s essay and a warning by a financial journalist that money market funds are “dangerous” places to have your money , there is ample justification for the American people to demand higher interest rates on their savings accounts and an end to the Federal Reserve’s monetary manipulations that transfer wealth from low and middle income savers to the banks and the nation’s financial elites and the federal government.
In short, is your “mattress” a better—and safer–place to keep your extra cash instead of a bank and money market fund? Should the American people do what is in their power, withdraw virtually all their funds from the financial system until we have “normal” interest rates? After all, how long will the American people keep subsidizing the federal government’s trillion dollar deficits and the fiscal irresponsibility of Congress and the Obama administration?
As retired economics professor Dom Armentano wrote last November (http://lewrockwell.com/armentano-d/armentano31.1.html), “The current Federal Reserve policy of quantitative easing props up the value of government securities and subsidizes U.S. borrowing and it does this at the expense of working and retired people who will continue to earn next to nothing on their bank savings accounts and CDs. This policy is inefficient and immoral and it should end. In addition, some economists believe (with good reason) that the U.S. Treasuries market has now become the biggest asset bubble in financial history. If and when it crashes, it will make the so-called ‘fiscal cliff’ problem look like a walk in the park.”
It’s up to the American people to end the greatest experiment in financial lunacy in our history. Are they up to the task?