Higher Interest Rates — A Positive Unintended Consequence

During the Great Depression, the unemployment rate never went below 10%, as it took World War II to get America back to work again. The great economist Milton Friedman taught us an invaluable lesson that the Federal Reserve did not understand at the time—during times of deflation, rather than allow depositors to cause bank failures when they panic and clean out their savings accounts, the Fed should have provided ample liquidity.

Defenders of FDR’s New Deal still refuse to heed this lesson, as their answer is to any problem is more big government spending. Lucky for us, Fed Chairman Ben Bernanke took Friedman’s advice after the 2007 meltdown, and provided the economy with liquidity just as money market accounts were about to fail.

Friedman not only gave us the remedy for deflation—but also an answer in times of inflation: “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.”

Yet over the past two years the Fed has increased the money supply by a staggering 40% while also supporting the $900 billion Covid relief package / $1.4 trillion government funding package for fiscal year 2021.

All this while the typical Fed policy was supposedly going to maintain stability with a target of 2% inflation. And the pre-pandemic economy already had low unemployment rates.

Usually, unintended consequences are bad. If and when the Fed wakes up today and changes to a policy that tightens the money supply by increasing short-term interest rates, and reduces much of its $8 trillion of assets in US government bonds and mortgages, the stock market will decline.

Why? One factor is that the dividend of the S&P 500 will no longer be as competitive with the yield on 10-Year Treasury notes.?

Another thing to look for is when US business investments switch from less investment in paper (stocks and bonds) to more investment in real capital (domestic semi-conductor factories).

But there will also be some beneficiaries. Retirees who need higher interest rates to live off their fixed incomes, and insurance companies that invest mostly in corporate bonds.

Higher interest rates will be especially welcome news to those who buy Hybrid Life + Long-Term Care Insurance (LTCI) policies with Inflation Protection Riders:

o???premium rate increases for new buyers should end

o???crossover ages should be lowered

o???new life insurers should enter the market

o???increased competition should eventually lower premiums