Why Higher Interest Rates Will Not Lead To Recession

It’s amazing all the panic I see when reading the news pertaining to higher interest rates.  Mortgage rates have gone up about 0.5% in the last few months, and stock markets have lately been hit by fears that the Fed will not only taper off Quantitative Easing, but will eventually raise the discount rate, which is pretty much the standard rate that many lending activities are based from.

The naysayers proclaim things like:

“Higher mortgage rates are going to kill the housing market recovery.”
“Higher interest rates will pop the housing bubble.”
“Higher lending costs will lead to recession.”

I’m sure you get the point.

Personally, I’m not buying it.

Demand fell.  Let’s look back to the reason that rates fell to the point where they did?  It was the economy.  Basically, companies and people stopped borrowing as the housing bubble popped, people were losing their jobs, and wealth was disappearing in the stock market crash.  All of that meant that credit was simply not in demand, which by the economic laws of supply and demand meant that rates had nowhere to go but down.

And they did.

But, now, they’re going back up, which is actually a good thing.  It means that there is more demand.  People want mortgages.  Companies want to borrow money.  These are not the signs of a fragile economy, but instead are indicators that the economy is indeed finding stable ground.

No permanent solution.  Low rates were never meant to be a permanent solution.  When the Fed stepped in and basically made the discount rate zero, meaning banks could borrow at no charge, this was meant to stop the free fall that the economy was in.

Now that we’re no longer in a free fall, the underlying reason for making the rates so low simply isn’t there.  Jobs may not be getting created as robustly as many would like, but we’re not shedding hundreds of thousands of them per month.  Housing prices are going up.  The actual number of homes being sold still has a ways to go in terms of recovery, but with the market showing such pent up demand, do people honestly believe that another bubble is right around the corner?

No more dirty work.  As the Fed tightens up their policies, it means that they are no longer responsible for shouldering the workload involved with our economic recovery.  Let’s think about that for a second.  With the Fed doing all the work, it’s been pretty easy for companies, including those in the financial industry, to sit back and let the Fed do all of the work.  The Fed has taken a lot of heat for getting so involved, but even if they become less involved, this shouldn’t mean that the economy will just collapse.  Instead, it means that the private sector now has to get back to hard work that they’ve been able to avoid for the last few years.

Since profits are at stake, you bet someone will do it.  Don’t believe for a single second that just because the Fed ‘backs off’ that nobody will pick up the slack.  Someone will see the opportunity to get back to business and will take charge.

This is a test.  This is only a test.  The stock market has been tested quite a bit since the Fed announced that they’ll taper things off (which leads to speculation that interest rate jumps aren’t far behind).  As I watched the stock market react day after day, I could sense that a lot of the ‘fears’ and ‘jitters’ and ‘uncertainties’ were merely posturing.

In fact, it felt to me like Wall Street was trying to needle the Fed into backing off from their plan to back off.  After all, if the stock market did a little mini-tank, wouldn’t that show that the market wasn’t ready for the Fed to back off of their control over the economy and maybe they should stick with it a while longer?

Am I saying that Wall Street was purposefully manipulating prices?  Well, it does seem to me that the activity for multiple days following the announcement should have already been priced in to a large degree.  So, if you follow the markets, draw your own speculation on that.  I’ll also say that I hope that the Fed doesn’t back down because of a few bad days.

In short, the Fed has made it clear that the days of free and easy money are coming to a close.  While this sends many people into a panic, I think it’s a great sign for our economy and indicates that even better days are ahead.

Readers, have interest rate changes spooked you or do you see it as a sign of opportunity ahead?

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