The title says it all if you know what you are looking at. A little history first then we will dive into the relationships between BRICS, the Dollar and Interest Rates and it will wake you up if you haven’t been watching the world. BRICS is the formation of a new currency based on precious metals formed to take on the dollar as the world’s new reserve currency, we will get more into that in a minute. The Dollar is our currency in the United States and is the current world reserve currency. Then how do interest rates play into this equation you ask? Interest rates may not react now to both of these currencies now but they will very soon.
BRICS stands for Brazil, Russia, China, and South America, they were the original nations that signed on to use this new currency. Since the formation of BRICS, Several other countries have signed on to use this currency, countries such as Saudi Arabia, Syria, Afghanistan, and several others countries. What this means is that these countries will use the BRICS currency as their reserve currency, not the US Dollar. This has not materialized yet but it is in the works. If this new currency catches on and becomes the world’s reserve currency and not the dollar that could have to reach economic consequences for the Dollar. If you are paying attention to what is happening in Ukraine right now you have to understand that this conflict is not about Ukraine’s sovereignty from Russia it is about money. Money has driven almost all wars in history and this one is no different.
The Dollar has been the world’s reserve currency since World War 2 and before that, it was the Pound Sterling (British Currency). The Dollar was originally backed by Gold and Silver. When the US was limited to gold and silver it could not expand as fast as those that held the gold and silver wanted it to so it moved from a currency that could be backed by precious metals to the Federal Reserve Note we have today. That transition happened in 1971 under President Nixon. The US moved to what some call a “Petrol Dollar” which is a dollar backed by oil. Again, we have seen wars fought over oil now, why? Money. Today’s Dollar is really only backed by debt and that is why the world sees the dollar as a dead currency where the debt has exceeded what a normal mind can grasp. $33 trillion dollars is a number that is not quantifiable to a regular person, numbers like that are for mathematicians. The dollar has been the great magical vehicle for decades with people believing it has actual worth and that belief has allowed the US to become the largest superpower in the world.
Interest Rates, how does it play into the currency game? This one will take a history lesson as well. Interest Rates, by definition, are the cost of money. Interest Rates in the US have been controlled by the Federal Reserve and the Federal Reserve also controls the Money Supply. We can now see the relationship as the Federal Reserve controls both the supply of Dollars and the cost of the Dollar. The Federal Reserve system has been under fire lately with the way they have managed this relationship as we have seen interest rates soar over the last few years. With the dollar as the world’s reserve currency for so long the Federal Reserve Bank has been lucky that countries like China and other countries that hold a large stake in the US debt have not called it due. If the world moves away from the Dollar as a reserve currency you will see the devaluation of the dollar worldwide and those still using the dollar will see it be devalued on the world stage. A devalued dollar will create inflation and the cost of the money will have to go up to offset this. The cost of money is interest rates.
This is just a quick view of those things to come and can also explain what is going on in the world today. If you connect the dots you can see why BRICS has come to fruition. War in today’s world is being fought on the economic front not so much on the battlefield. If the BRICS currency takes over, the dollar will devalue and the cost of things in the US will skyrocket. If we have high inflation we will have high-interest rates. When you look at the conflict in Ukraine understand it is not about Ukraine at all, in fact, if you look at Ukraine you will find that their government has been corrupt for decades. If you research President Zelenskyy you will see he started off in life as a comedian and actor and worked for a TV station prior to being “elected” President of Ukraine in 2019. Zelenskyy’s net worth is estimated to be between $20 and 50 million US dollars, and some estimate it far greater than that. Meanwhile, the US has recently sent Ukraine over $120 Billion in aid. These are facts; you can even google it and see that the search engine has not yet closed the door on this information. It is on top of this administration’s list to keep the dollar as the world reserve currency to keep America the strongest and richest country in the world. When you are watching or listening to the news, however, you find your information, keep money in mind when watching as that is the underlying cause for almost every conflict in the world is money. I tried to keep this to facts that we know, but I think if you peel the onion back a bit more you will see things and understand things that you may not want to have knowledge of. There is a lot more to this that I can’t possibly go into for this short blog post so keep your eyes and mind open.
The Federal Reserve has raised the Federal Funds rate by 50 basis points or .5% last year 2016, so what does this mean? Although the Federal Reserve does not control interest rates on homes, it does control interest rates that banks lend to each other called the Fed Funds Rate. During the same period interest rates on home loans rose by 50 basis points as well. The policy of the Federal Reserve Bank has been to use interest rates to quell inflation. This policy started back in the mid 1980’s with Paul Volker as Fed Chairman. The concept or policy is that if the Central Bank (the Federal Reserve Bank) senses that inflation is threatening the economy interest rates are raised to slow the flow of money thus keeping inflation at bay. This has been the Fed’s policy and it has been working, for the most part for the last 30+ years. The question should be asked if this should be continued or modified as our economy has gone more global than ever before and coupled with a National debt over 20 trillion dollars, does this policy still work for the American economy?
Let’s first look at what the effects of higher interest rates are in the American economy and then what it presents to a worldwide economy. In America in a higher interest rate environment it becomes less desirable for large projects to start as the higher cost of the money will have impacted the profitability of the project. For example; if a large development project is evaluating the costs to build and what the profit margin is going to be at the end of the project the cost of the money to complete the project will directly effect profitability. I addition, if they are going to borrow money at say 6% and the interest rates rise to 6.5% on a $100 million financed the difference in annual payments would be $500,000 a year. As you can see this dramatically impacts the profitability of the project. So, in theory, less projects will start in a higher interest rate environment thus less employment and less money flowing into the economy to push prices on goods and services higher. So, what you get is a general slowing of the economy under this theory that has been used by the Fed for the last 30+ years. What higher interest rates do to potential home buyers is cut the buying power for potential home buyers. With a .5% rise in interest rates the buying power of a home buyer will decrease by $30,000 on the average. So, with the new interest rate being .5% higher a potential home buyer will qualify for $30,000 less of a home. This combined with slower job growth from large projects not starting will slow the economy thus inflation.
Now what happens worldwide when America raises interest rates? This is the part of the equation that I believe has not been fully evaluated by the Federal Reserve system. It used to be if America raised rates other countries would follow thus keeping the dollar on par with other currencies around the world. Also, our debt was believed to be under control back then so other countries would just follow America’s lead. What has happened, and has not really been taken into consideration from our central banking system, is that more outside countries hold our debt and more outside countries have joined the European Economic Union, that did not exist in the 1980’s and some important countries have now left that as well. China has become a superpower as well. All the while, in America, our basic concepts of raising and lowering interest rates to the effects of our economic numbers has remained the same. My question to the Federal Reserve would be why have you not changed with the times?
With my degree in economics I have used these concepts to anticipate interest rate movements for the last 30+ years and I have been pretty accurate over the last 30+ years in doing so just from knowing these basic economic policies of the FED. I have also observed over the years that the numbers that the Fed uses to predict inflation have become more abstract than ever before. The Federal Unemployment number has been the bench mark for the Fed's analysis of interest rates and when to raise them. The unemployment rates, traditionally, show the percentage of people that are collecting Federal unemployment. The theory has been that if unemployment is low, under 6%, then America has been deemed to be in a healthy economy with a higher probability of inflation. Remembering that the concept of inflation is that if people are making more money they are spending more money thus putting upward pressure on prices of goods and services or inflation. The Fed has consistently used the unemployment number as a barometer of future inflation. Problem is that since our recession of 2008-2011 these numbers have not been accurate and the actual term or length of unemployment benefits that an out of work worker can get has gone up to 99 weeks from 26 weeks. What we have seen that, since the recession is people have gone back to work but at a far less wage then they had prior to the recession. This lowers the unemployment number but is not an accurate depiction of how that same worker may spend the wages they are now receiving. We have also seen a shift in family dynamics with one spouse staying home with children to combat the high costs of day care, thus taking that person out of the unemployment number entirely. So, although we have seen a significant decrease in the unemployment number we have not seen family incomes rise to the pre-recession levels and we have not seen the kind of inflation that should happen under a full employment economy.
With a rise in interest rates over the last few months we have seen the refinance market slow to levels that were pre-recession. It appears that most people have been able to refinance to the lower interest over the last 6 or seven years so the demand to continue to refinance has diminished. With higher interest rates it has become less attractive to refinance. One of the consequences of the higher interest rates is that the flow of income slows to the lending industry and will eventually lead to layoffs in the mortgage industry as it has been a strong market for so long that lenders have staffed to fill the old refinance volume needs and now with less volume they don’t need the staff. These folks will increase the unemployment number by May or June of this year as there is always a time lag when there are changes in the economy, hopefully the Fed does not do another increase in the meantime as that will lead to more layoffs. Although rates have risen interest rates on home loans are still in the 4’s which is still great, so if you have not refinanced and your current rate is in the high 4’s or fives, or if you need to take cash out of your house to pay for bills or college there is still time to lock into a good interest rate.
I am just scratching the surface with regards to the factors effecting interest rates and inflation in this article. I am a believer that in a global economy and the changes that have taken place over the last 30+ years we should be looking at interest rates from a different set of rules. Our Government has traditionally been reactive to changes in the economy as opposed to being proactive operating on a policy of ”it works until it doesn’t”. The result is government intervention to fix it, which has never worked and just has put America further into debt and burdened with a larger government with more and more government agencies than ever before. I don’t want to get political here but what has made America an economic superpower in the past was that people were free from government intervention to create new ideas and new products and services. With this freedom came the knowledge that if you fail, big or small, no one including the government would bail you out. This has changed radically with people looking to the government for solutions where they should be looking to themselves and realize that win or lose it is up to the individual to make things right, not government. We need to become more self-reliant than a dependent society. These factors also need to be factored into the Fed’s analysis of inflation and how to combat it.
So if the current Federal Reserve policy is to use the unemployment number as the main factor in determining whether or not they should raise interest rates we will be heading into an economy where we will see higher volatility with interest rates and the economy as a whole. With the Fed and Janet Yellen (Current Fed Chairperson) looking to raise interest rates again this year we will be looking to an economy that might be cooled off too much. Some inflation in a healthy economy is not a bad thing so long as wages can keep up with it. We can look too see home refinancing slowing down this year with the higher interest rates and hopefully home purchases don’t slow too much as that could put America right back into a recession. It is a balancing act for the Fed to change rates as they really don’t know what the end effects will be and if they have gone too far. As always this is just an opinion of a guy who has been in the mortgage industry for 32+ years and if you wish to comment feel free and if you have not refinanced we would love to assist you with that at MAE Capital Real Estate and Loan. You can call our offices directly at 916-672-6130 or email us at info@maecapital.com. Post Script 3/20/2017 The Federal Reserve (The Fed) raised the federal funds rate by .25% which was anticipated by the markets. Since the Markets liked the only .25% increase the DOW Jones rose to new highs. The important part of the announcement was that they would be monitoring the unemployment rate and inflation throughout the the year and if they see any increases in inflation and significant decreases in the unemployment number they would then raise rates again. We can only hope the Fed doesn't raise rates anymore or it could significantly reduce the availability of housing and affordability. Key indexes that you need to watch to see if there is any inflation; one the stock markets, as this will increase wealth of individuals and they may pull it out and use the funds to purchase other items that could cause inflation. Watch the unemployment numbers and watch them per the season, as spring and summer should have seasonally lower unemployment but not too low where there is a higher demand for workers than there are workers to fill the demand, I don't see that happening but that will cause inflation. I see a steady healthy growth during the year if rates are not increased anymore.