Clifford Neely's  Instablog

Sidney Homer, the author of "A History of Interest Rates," first alerted us to the fact that excessively low interest rates are a signal that a nation is in serious economic trouble. Mr. Homer's seminal study of interest rates from prehistoric times to the 1960s led him to conclude that very high or very low interest rates are a symptom of a nation in its end days. By this measure, we are in great trouble for the overnight bank-lending rate (Fed Funds) has been near zero for three years and we are promised it will stay there for another year and a half.

We learned first hand just how destructive high interest rates could be by living through the 20% interest rates of the Carter Administration. We are now learning that abnormally low interest rates are equally onerous. Abnormally low interest rates penalize savers and reward speculators.

Abnormally low interest rates create impatient money. They force investors to accept more risk for higher returns. Paltry interest rates lead to highly leveraged debt bubbles. Ironically, the bursting of a bubble makes even lower interest rates mandatory to stave off an economic collapse. We are in such a series of negative feedback loops. Low interest rates are both the cause of and the only cure devised so far to contain the current string of financial bubbles.

We are in a hole and it is time to stop digging. The imperative is to stop borrowing and begin the arduous process of paying down the debt that now smothers consumers, businesses, and the federal government, The need is to create 30 million high paying jobs in a matter of a few years so that rising earnings reduce the debt to manageable levels.

Capitalism will not long tolerate interest rates at their current level. Our economic system is under threat until interest rates return to levels where savings can earn 3% in real terms over time.

Public opinion is starting to coalesce around the belief that the answer to the nation's debt problems lies in becoming energy independent. Buying foreign oil siphons off about $400 billion from the US every year. What this growing consensus is not properly reflecting is that oil from coal has to be a big part of this mobilization to energy independence. Coal is our lowest cost energy base and coal liquefaction is the lowest cost route to liquid hydrocarbons.

Right now, we are buyers, not sellers. We have little to sell that the rest of the world wants to buy. Oil from coal changes all that and is the way to once again print a healthy yield curve.