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Unlocking the Money Matrix - The Real Interest Rate (PART 12/15)

Unlocking the Money Matrix - The Real Interest Rate (PART 12/15) 0 comments
Jun 17, 2009 11:17 am
Since 1990, the Real Interest Rate has been negative and continues to plummet. This negative rate of interest is causing the capital destruction we see in America today. The stock market and real estate booms and collapses are merely symptoms of this root cause.
by Jake Towne, the Champion of the Constitution
Wednesday, June 17, 2009
  • "Interest is the difference in the valuation of present goods and future goods; it is the discount in the valuation of future goods as against that of present goods."

      - Ludwig von Mises, Human Action, 1949.   (photo license)

    Consumers in our modern market economy primarily use government fiat debt-based currency. Historically and currently, these currencies are inflated and debased by central bankers. Quite possibly THE key factor to understand is the concept of interest rates, and the "real" interest rate I will introduce in this article. (see note 1)

    As related earlier in the series, when dealing with fiat currencies like the dollar, it does not matter how many dollars you have, but how much purchasing power you can command. Each consumer makes a conscious action to either spend the currency have or save it, usually in a bank. When saving, the consumer usually does this because they believe the purchasing power they are saving up will be of more utility - to "remove them from uneasiness" as Mises puts it - in the future.

    Modern banks still pay positive amounts of interest in dollars, but as you will shortly see, the rate of inflation has been high enough that the "real rate of interest" is negative. As an individual acting in the marketplace, your personal "equation" for the "real rate of interest" for fiat currencies is simply:

    Real Rate of Interest = (Interest Rate earned by a bank savings account) minus (Inflation Rate)

    Interest rates earned by bank accounts or short-term CD's vary but they tend to track very closely to the federal funds rate, which is manipulated by the FED. The federal funds rate is simply the interest rate charged by one bank to lend to a second bank. As banks tend to pay interest on deposited consumer funds at lower interest rates, the federal funds rate serves as a best-case figure for the interest rate earned on a bank savings account. In other words, by using the federal funds rate, I am over-simplifying the equation but also giving the government the benefit of the doubt as the federal funds rate is usually higher than what a consumer savings account would receive.

    Likewise, the inflation rate is also impossible to clearly define and must be approximated. Why is this so?  Well, consumers change preferences, new goods are constantly introduced, and the quality of goods vary from time to time and from location to location. However, the optimal way to track this is by monitoring a basket of goods and commodities over time. The government's Bureau of Labor and Statistics best statistic for this is its Consumer Price Index for Urban Wage Earners (CPI-U). However, as John Williams of has explained in this article, the government has falsified the CPI in order to illegally diminish the amount of Social Security payments without requiring Congress approval. The government has done this by:

    1. Altering the weighing of certain components of the basket in a beneficial way

    2. Substituting alternate goods, say instead of filet mignon, they substitute ribeye steak, then later hamburger, and eventually perhaps even a peanut butter and jelly sandwich, and then perhaps dog food. These statisticians claim that in tough economic times, the consumer be forced to downgrade their selection of goods (which is true). However, masking the degradation of living standards is certainly NOT the purpose of an inflation indicator!

    3. Next is "intervention analysis" which is used when a commodity, like gasoline, goes through swift and significant price swings. Intervention analysis is done to tone down the volatility of the CPI - in other words, so that the CPI does not change rapidly along with price of gasoline. Williams (and I) have observed that rising gasoline prices never seem to get fully reflected in the CPI, but the declining prices sure do. Here is a BLS example.

    4. Lastly, the government uses a practice called "hedonics." This manipulation adjusts the prices of goods for the increased pleasure the consumer derives from them. When the price of gasoline rises because of a federally mandated gasoline additive, the increased gasoline cost does not contribute to inflation. Instead, the increase is eliminated from the CPI because of the offsetting pleasure the consumer gets from breathing cleaner air. You can read the latest BLS "hedonic quality adjustment" for clothes dryers here for a taste of what I mean.

    For comparison, I will also show the official government BLS data, but as you will shortly see, it makes no sense. I have reviewed the ShadowStats methodology and believe it to be the most reasonable and accurate statistic available. So the equation from above becomes an approximation:

    Real Rate of Interest ≈ (Fed Funds Rate) minus (ShadowStats SGS-Alt Inflation Rate)

    The chart below shows the Federal Funds Rate (yellow), BLS CPI-U (red), and SGS-Alt (purple) inflation rates. Note that until 1983 the CPI-U and SGS-Alt overlaid perfectly. From 1983 until roughly 1992 there was a small difference, and following 1992 the difference widened tremendously. Note that in April of 2009, the BLS claims an inflation rate of roughly -1% while Shadowstats is at +7%.


    The next chart is the computation of the Real Rate of Interest, calculated with both SGS-Alt and the BLS number. For instance, the government figures suggests that dollars in placed in a bank account plus its accumulated interest grew in purchasing power since 1992, save for a couple minor excursions into negative territory. However, a quick comparison with the prices of normal consumer purchases reveal this to be a lie. Although farming techniques have certainly improved and should theoretically cause a deflation in the prices of milk, eggs, or a loaf of bread, this is not the case with our fiat dollar. All these prices have, to be very conservative, at least doubled and tripled. Same with gasoline. There is no way that dollars plus interest from a bank account could keep up with these price increases.  [Keep in mind these are all staples which are far better general indicators of the dollar's purchasing power than technological goods like computers.]


    Finally, we have our chart for the real interest rate from 1970 to April 2009 below. One can see that since FED Chairman Paul Volker squeezed all of the inflation out of the monetary system in 1980, there has been a steady, almost linear drop in the real interest rate. Since 1990, this rate has been increasingly negative and is currently at -7%. (see note 2 on why this "Volker squeeze" will likely not occur again)



    When the real rate of interest is negative, the purchasing power of your currency saved in a bank account is dropping, even though the amount of dollars is rising - this can only happen because each dollar has been debased by the FED and now purchases less. Of course, the real rate of interest could also made negative by events such as a military invasion or hyperinflation. Whatever the event, what this means is - back to Mises' definition - that goods and services in the present are preferred to goods and services in the future.

    Above all else, a negative real interest rate signifies America's savings and capital is being destroyed. The State is responsible for the capital destruction of our society.

    This explains why our best jobs and factories have been driven and outsourced overseas - and why most consumer goods are from China.

    This is why we are living in a Depression and unemployment is at 20% - you didn't really believe the government unemployment figures of 9%... right??

    This explains why the American consumer "saved" in the stock market and "saved" in the real estate market; we all instinctively recognized that leaving dollars in the bank would not generate enough purchasing power in our child-raising and retirement years, so as a society we invested and speculated in these markets.

    This explains why Social Security recipients find it hard to get by - their monthly checks should be twice as large to make up for the purchasing power they were promised by the State.

    This explains why families now need two wage-earners instead of one, why our children spend more and more time in day care while Mom and Dad struggle to make ends meet.

    In short, the simple graph of the "real interest rate" demonstrates quite a bit.  But where has this wealth, this purchasing power, gone??

    Our lost purchasing power has been stolen and confiscated by the State - the central bankers, large multinational corporations and the military-industrial complex have been the key recipients of the State's ill-gotten gains. (photo)

    This theft has only been made possible since the "money power" belongs to the State, not to the people, where it belongs.

    Part 13 will complete the story as to how the State fooled us all for so long. For our central planners knew mere "dollar magic" would never work unless the proverbial yellow canary in the coal mine was slain.

    Unfortunately for the Establishment, our canary was not killed, it was merely muffled. Yes, I am talking about the suppression of the gold price, the Summers Suppression Plan.

    Jake Towne is running for U.S. Congress in Pennsylvania's 15th District in the 2010 election as a citizen unaffiliated with any political parties.  Jake also writes at and www.CampaignForLiberty.comA master campaign presentation for internet viewing is available.  [Reach the Author Here!] 

    Note 1 - While the Mises quote above is true, in my view of a contemporary market economy, interest rates also serve as a type of check-valve between the deployment of savings (or capital) for economic growth and the savings (or capital) deferred to the future to pay for the goods and services resulting from this economic growth. However, in a world of fiat monetary inflation, credit is also created by the banking system (How? see Part 6) to stimulate economic growth. Credit can even be created to artificially fuel the consumer consumption of the goods and services. Unfortunately, periods of credit expansion are by definition also periods of debt expansion; for every unit of credit extended, there is a debtor. Historically, due mostly to central bank manipulations, natural corrections cannot occur, and these credit expansions balloon and dwarf real assets - companies, property, commodities and then result in often-chaotic credit contractions. (see slides 38-40 here)
    Very importantly, this credit-fueled stimulation also resulted in plenty of what Misesian economist Thomas Woods, author of Meltdown, terms mal-investments.  Mal-investments can be either corruption, increased amounts of failed investments (which always happen in a free market), but also failed investments that were solely due to the entrepreneurs being "tricked" - they believed the consumer would have enough purchasing power in the future to purchase their goods or services, when in reality they will not.

    Note 2 -  Logically, one would also wonder if increasing real interest rates like Volker did in 1980 would also work right now. Unfortunately, I do not believe this will work - rather than spend another article on the topic, here's my attempt in brief.  First, the debt load is too high increasing the purchasing power of saved dollars would likewise increase the purchasing power which must be paid to our creditors, and which must be extracted from the unfortunate taxpayer - us - who increasingly do not have the income to spare.  Second, as shown in Parts 9-11, this would cause most of the OTC and EXD derivative contracts involving interest rates to end, which would probably (since the credit markets are opaque) result in an unbelievable number of bankruptcies, particularly with the banks. Since the Banker Bailout of 2008 we all know where the true sympathies of Congress lie - with the banks and preserving the "money powers" of the State, not We the People.