The full editorial:

Interest-ed?

By Ed Wallace · May 22, 2020

WHEN YOU PRICE INTEREST FAR BELOW THE REAL INFLATION RATE, YOU ARE IN FACT PAYING PEOPLE TO BORROW MONEY FOR WHAT THEY WANT.

Sixty years ago, John Kennedy started the practice. But over those six decades many presidents have continued it — massaging the official government economic data a tiny bit here and there. Nothing done maliciously, just tweaks to make the economy look better than it really was to validate any given administration’s decisions.

Richard Nixon, for example, asked Fed Chair Arthur Burns to come up with a report secondary to the Consumer Price Index, one that would exclude the most volatile goods, such as oil and food prices, not to mention U.S. wages and the price controls that would end in 1974. And when Burns created “Core Inflation” we began reporting inflation without counting any goods that were inflationary at the time. Or America’s victory over inflation, just one of the most inflationary periods in our economic history began.

In 1983 President Ronald Reagan worried that the Consumer Price Index was overheating again, this time because housing prices boomed after mortgage rates fell rapidly, and the economy was once again in expansion. So the Bureau of Labor Statistics created what is still known as Owner Equivalent Rent. Meaning, if you owned a $150,000 home and two years later it was worth $200,000, but the rent only increased from $1,000 to $1,200 a month, that lower rent figure would be substituted to show inflation was not really an issue in housing.

President George H.W. Bush worked with Michael Boskin, chair of his Council of Economic Advisors, to find ways to alter our official statistics “away from the old industrial methodologies and toward the emerging services economy.” Many believed this was another attempt to lower stated inflation, which in turn would lower federal government outlays, including interest on the national debt and COLA increases for retirees. Oh, and that’s when we went from reporting the Gross National Product to the Gross Domestic Product, which was always a little rosier.

In 1994 Bill Clinton removed forever the 4 million long-term unemployed, who had no hope of finding a job and therefore gave up and quit looking, from the U-6 unemployment numbers. Ergo, last year’s 3.5 percent unemployment rate is nothing like 1968’s because the labor force participation rate is 6 points lower today.

But Clinton was just getting started. He also added product substitution to the Consumer Price Index. You used to eat ribeye, but its price went from $4 to $15 a pound, so you bought ground chuck instead; well, you were still eating meat, so — you guessed it — no inflation here. Clinton’s geometric weighting meant if something you really liked went up in price, they assumed you would buy less of it, so you’re spending no more money on that product — therefore, you guessed it, no inflation here. Then came Clinton’s hedonic adjustment to inflation, which claimed, without evidence, that sometimes prices go up because of higher quality. That may be true, but it’s being used without testing to prove its validity. Oh, and Clinton reduced the survey of homes from 60,000 to 50,000, with many in lower income neighborhoods removed to make the poverty levels appear a bit lower.

So, what was the point of administrations altering all these numbers to make them look slightly more successful? Because doing so had another outcome: It showed inflation was disappearing and therefore official interest rates could be lowered. And if one had truly low interest rates, they could spur the economy — while also allowing the government to lower its costs of benefits and entitlement programs, not to mention creating huge federal deficit accumulation; because, with virtually no interest to be paid on it, there would be more tax revenue money left for other things.

The downside is that when you price interest far below the real inflation rate, you are in fact paying people to borrow money for what they want. That’s both good and bad. The good is that, when General Motors offered Zero Percent Financing for 84 months and with deferred payments, even with dealerships locked down due to the coronavirus customers were calling and buying GM trucks and SUVs. On the other hand, national banks get access to dirt-cheap money and can charge whatever they like putting it out. Case in point, my own bank is currently paying 1 percent interest on savings accounts. Yet they have raised their interest rates on credit cards from 7.25 percent a couple of years ago to 14.49 percent today.

Let’s see: Assume you have $100,000 in Bank X and they transfer that to their credit card division for rollover on purchases; in one year’s time Bank X will have grossed $14,490 on your money, less writeoffs and expenses, while returning only $1,000 to you as thanks for using your money. Decades ago, when that earnings equation was based on a 7.25 percent credit card rate, the customer who saved money got the lion’s share because passbook savings earnings might have been 5 percent.

So, yes, when zero percent financing comes up on automobiles it’s a great call to action for the public to buy a new vehicle. But on a much larger scale, large banks can also borrow and pay virtually nothing for money from you; that means they and their upper line clients with money to spare end up chasing better but often riskier yields elsewhere, because most old-line investment opportunities aren’t paying squat either. So they go for riskier investments, like junk bonds. Ford’s recent pricing of $8 billion in bonds carries a yield of over 9 percent. For those buying those bonds, that’s a lot better than simply putting their money into the much safer savings account for 1 percent, less fees.

Ok, Zero for 84 is great when you are borrowing money for a new car, but as many dealers will show you, often taking the huge factory rebates and a reasonable interest rate on a loan is in many cases the more valuable option. (In this case it’s not a true zero percent, the automaker is buying down the interest rate from their bond costs.) And that brings us back to today’s reality. Sixty years of presidents toying with the economic data — with the net result of making inflation look insignificant —has brought interest rates down to the level of near nothing in the face of the real inflation that’s really happening. But it’s also helped create one financial bubble after another, all of which blow up sooner or later. Money chasing riskier yields in a low interest rate environment caused the Asian Financial Crisis of 1998 and the Financial Meltdown of 2008; and it contributed to the quick falloff in stock values and the economic contraction happening now due to the pandemic.

Here’s a good way to prove that, and how it works against us. Let’s say in 1953, the year I was born, my parents saved up $2,500 to buy a new car. Instead they put it into a 5 percent savings account for me to use in my retirement. Today that would be worth $70,762. Now, let’s use that same calculation, but put in today’s 1 percent savings interest rate, and there would be a mere $4,884 in that account. So, a reasonable interest rate that mirrors real-world inflation is a great start on a nest egg; the other rate devalues your money. But this is what we have left to our kids and grandchildren for their future. So, it seems equally strange that the very government that created this scenario is also pushing our younger generations to save more money because government safety-net programs may not be there for them in the future.

Given this, anyone can see why money lenders love their new artificially lowered interest rates and why they’re sold to the public as a great way to save money on your next new purchase. But few realize that that same below-real-world inflation interest rate is why COLA isn’t as strong as it should be, why government deficits can run wild, and why our investment economy looks more like Vegas slot machines.

The worst part of all of this has destabilized our economic society’s financial system numerous times in the past few decades, because it dovetails so nicely with the deregulated markets we’ve created over the past 30 years. Too much money at a far lower cost than inflation? Great, let’s put it in subprime loans and Alt-A mortgages and cause housing prices to skyrocket until reality kicks in. Same scenario afterwards — but, instead of mortgages, best put money into stocks as the Dow roars from 6,517 to 28,000 … until a Black Swan event throws cold water into everyone’s face and the hype ends. Remember, it took from January of 2009 to April of 2014 to recover the 8 million jobs lost in the last meltdown; one wonders how long it will take to recover our neighbors’ 36 million jobs now.

But it’s also why an American transportation company can lose $11.4 billion in just 15 months and pay its CEO $42 million for doing so; then he wants to go pay $6 billion to buy a competitor that also loses money, that money-losing competitor laughs and says, that’s not enough to buy us.

And we think that’s a sign of normal economy activity. That story next week.

Special thanks to Kevin Phillips and his exceptional book, Bad Money: The Inexcusable Failure of American Finance, for the economic data. Ed Wallace is a recipient of the Gerald R. Loeb Award for business journalism, bestowed by the Anderson School of Business at UCLA, and hosts the top-rated talk show, Wheels, 8:00 to 1:00 Saturdays on 570 KLIF AM.