WINNERS AND LOSERS WHEN INTEREST RATES RISE AND FALL

Years ago, while working with the World Bank, in redevelopment of financial systems for bank systems in Asia and Europe, I prepared a 200+ slide study of the Winners and Losers in the Global Economy. One of the major sections of this study was the impact of regulation and deregulation on economic activity. Another was the impact of high and low interest rates in a global economy. 

The results have been quoted, copied, and utilized in over 30 nations. We have see college professors, economists, banking experts, and government regulators in numerous nations use our materials.  These results are just as relevant today as they were in the 1980's and can be instructive to leaders who need to plan for their businesses, governments or even family economic security. 

Once, while passing through Washington D.C. after an extensive tour of Asia, presenting at symposiums for bankers, I had occasion to speak to William Grieder.  My presentation, called "Winners and Losers in the Global Economy" came to similar conclusions of Mr. Grieder, and I noticed that later in his book released in 1987 that he included a chapter called "Winners and Losers".  It seems that the facts were so obvious, that an author in Washington, DC and a banking expert (me) from Texas working in Asia, came to the same conclusions, albeit we were a world apart in career and work. 

Consider two scenarios.   I want you to imagine 5 people.  All but one, are worth say, $1,000,000 and one is worth $1,000.  One, a waitress in a café in Iowa, has a car loan and has purchased a small home based upon a variable rate mortgage loan. She, with tips can just cover her car payment, her house payment and her meager living expenses, including day care for her infant child. The bank lender in New York, has a salary of $150,000, a company car, an expense account of $38,000 per year(total adjusted income of $188,00), a resort home in Colorado and a penthouse in the City.  One man  owns a manufacturing plant in Detroit, he is fully leveraged in loans to pay for his equipment, and his salary OF $150,000 and bonus ($25,000 average) is based upon company earnings. One is a farmer in Iowa, and he has farm tractor and farm land loans and in a good year, with good farm prices, he can make $150,000 to $250,000 per year, but he also has sizable loans on his land and equipment.

Indeed without federal tax deductions on interest rates, his cash flow would be neutral in an average year. One is a retail business owner in a small town in West Texas. 80% of his income comes during the November, December Christmas buying season, and the rest of the year, his retail business just breaks even. But when there is a good local economy, in the oil, gas, ranching and farming industries, he can make as much as $90,000 per year.  The waitress just want to make her house and car payment and keep her baby in safety and comfort.  

Here is your first test question. 

Say interest rates are increased by the Federal Reserve Bank, through a process to tighten money supplies, from 4% to 10%.  Who are the winners in this scenario and who profits by this scenario: 

WINNERS AND LOSERS WITH AN INCREASE OF INTEREST RATES BY 6 PERCENT	DECREASE OR INCREASE IN INCOME WHEN INTEREST RATES RISE	COMMENTS AND FURTHER IMPACTS
BANKER WITH $1,000,000 CASH	INCOME LENT INCREASES INCOME $60,000 RAISING HIS TOTAL INCOME TO $248,000	The person with cash further increases his income buying power, because as real estate, commodities, and businesses go down in value by 20%, he can buy them for 20% cheaper.
WORKER WITH A HOUSE AND HOME MORTGAGE	INCOME MAY DECLINE WITH REDUCED TIP AND EARINGS BECAUSE  OF SLOW DOWN IN BUSINESS. EXPENSES INCREASE AS PAYMENTS ON HER VARIABLE RATE MORTGAGE INCREASES	The person who has borrowed money for necessities such as a home, a car and has a variable rate income, is punished  by both rising rates, and lower income. Millions of people such as her will be forced on welfare, and often will lose their homes.
MANUFACTURING COMPANY OWNER	THE MANUFACTURING COMPANY LOSES INCOME OF $60,000 IN HIGHER INTEREST PAYMENTS, BUT ALSO LOSES AGAIN, BECAUSE HIGHER INTEREST RATES TEND TO LOWER DEMAND FOR NEW PURCHASES.  HIS BONUS WILL DECREASE AS WILL HIS SALARY TO 95,000, EVERY PENNY TO BE SPENT ON DEBT AND EXPENSES.	The manufacturer sees his asset and collateral values decline as the economy suffers, thus his ability to borrow more dissolves.  He may have to file bankruptcy or restructure to survive. He may have to sell his assets at a discount to the banker/lenders. Further, exports decline because other nations cannot afford to buy US goods when interest rates increase.
FARMER	THE FARMER HAS AN ADDITONAL $60,000 IN INTEREST EXPENSE, AND PATTERNS SHOW THAT DEMAND FOR FARM GOODS, COMMODITIES OFTEN DECLINE AS INTEREST RATES INCREASE, BECAUSE THE RESULTING SLOWDOWN. HIS INCOME IS AT THE MERCY OF THE FEDERAL RESERVE BANK POLICY AND THE WEATHER/CROP YIELDS.	Farmland, farm equipment, livestock, all decline in market value. If the weather brings a below average crop year, this coupled with lower commodity prices, may bankrupt the farmer.  His problem is futher compounded because demand for US agricultural products declines when U.S. Interest rates go up, because developing nations cannot afford to import U.S. goods.
RETAIL STORE OWNER	IT IS SAID THAT THE UNITED STATES IS A CONSUMER DRIVEN ECONOMY. BUT THE RETAILER WILL SEE AN INCREASE IN INTEREST EXPENSE OF $60,000, AS HIS RETAIL SALES DECLINE	As consumer confidence declines and more people are laid off by the farmer and the manufacturer, the retail and consumer industries get hit from lack of demand and higher interest payments.

In the above scenario, the bankers, the owners of finance and capital profit when rates are high, but every one else seems to  lose and the overall productive economy of jobs, manufacturing, retail and farm production suffer. In a nation of 300,000,000 people, as many as 30,000,000 people could become unemployed in high interest rate environments.  Power, property, and control gravitates to the bankers, the lenders and those who profit from higher interest rates.   

When I was a young banker, there was a political leader, Wright Pattman, who spent a lifetime studying the impacts of interest rates on people, business and the general welfare of American people.  He was  U.S. Congressman from Texas in Texas's 1st Congressional District and chair of the United States House Committee on Banking and Currency (1965–75).His conclusion was that high interest rates benefit the bankers, the rich, the powerful, and tend to move power away from heartland America, to concentrated power in a few hands. He considered it destructive to the people of the United States to allow banks and the Federal Reserve system, promulgate high rates or tight money. During the Great Depression Wright Pattman exposed the Treasury Secretary Andrew Mellon's advice to President Herbert Hoover which was:

"To liquidate labor, liquidate stocks, liquidate farmers, liquidate real estate... it will purge the rottenness out of the system. High costs of living and high living will come down. People will work harder, live a more moral life. Values will be adjusted, and enterprising people will pick up from less competent people." Additionally, he advocated weeding out "weak" banks as a harsh but necessary prerequisite to the recovery of the banking system. This "weeding out" was accomplished through refusing to lend cash to banks (taking loans and other investments as collateral), and by refusing to put more cash in circulation. He advocated spending cuts to keep the federal budget balanced, and opposed fiscal stimulus measures.

In January 1932, Rep. Wright Patman (D-TX), introduced articles of impeachment against Mellon, with hearings before the House Judiciary Committee at the end of that month. After the hearings were over Mellon resigned as Treasury secretary in February. 

The philosophy of Mellon still prevails among many of America's old money banking giants and is most prevalent in the extreme elements of the Republican Party of the USA.  Many believe that there has been a 100 year battle in the USA for the control of the US economy, between those who represent big money, and those who represent "people, jobs, production, and local economic growth".  My grandfather, said it correctly in 1929, "Under Republicans, farmers, merchants and working people are not favored as much as big banks, big business, and wealthy barrons."   I didn't realize that he was correct until I became the President of a community bank, and spent time visiting Washington D.C., and leaders of Money Center banks in New York. I soon learned that the ethic of economics of the big boys in New York, was entirely different from our populist culture in Texas and heartland.  They were for concentrating wealth and power...we were for spreading it around and giving everyone a piece of the pie.  Grandfather, proved to be right, and to this day, his ideas are still on target. 

THIS CONFLICT COULD BE FURTHER DEFINED AS A BATTLE BETWEEN THOSE WHO BELIEVE IN AN ECONOMY REGULATED, AND ONE TOTALLY FREE FROM REGULATIONS 

We note the history of the Dow Industrial Average, from the 1880's to 2013.  During the late 1800's the US economy was one of numerous booms and busts, and it was essentially a "Deregulated" economy. The "Barrons" of Wall Street, the super wealthy industrialists and bankers, essentially controlled the economy and used it to their benefit.  Thus every 2 to 7 years there was a boom and a bust. During the boom phase, money cost was low, and expansion prevailed. Money would become tight, interest rates increase, and a bust of over supply and over production would occur. Then as commodities, real estate, corporate and property values dropped, the rich with cash and capital would buy the assets at discount rates and a general concentration of power and money occurred. It is said that 7 to 12 men controlled most of the wealth in America during parts of this time.  In 1920-28, there was wild unregulated leveraged speculation, and when the panic hit in 1929, men such as J.P. Morgan and Andrew Mellon promoted a policy to tighten the nation's money supply in a "depression" to punish and fail millions of people, and thus heal the economy.  Millions of American businesses failed, millions of Americans lost jobs and thousands died. Farmers, merchants and heartland businesses died by such numbers that "heartland " America was permanently harmed and power flowed into concentrated hands of the "fat cats" on Wall Street. 

With Roosevelt, there was a call for well conceived systems to stabilize the US Economy, and banking and finance was regulated. This created the foundation for the longest period of economic growth and stability we have seen, from 1935 to 1975.  In the mid 1980's with people such as Paul Volker at the head of the Federal Reserve, and Ronald Reagan the President, the old hoary head of Morgan and Mellon rose again, and the economy was again squeezed, while deregulation was taken up as a banner for the Republican Party and for business in general. What most business owners did not realize was that the deregulation that they were blindly adopting, was gutting the very laws and system that had protected them and made their success possible. It was only until the extreme "tight money and high interest rate recession" brought about under Ronald Reagan and Paul Volker, that the thousands of bankers, famers and businessmen who had failed recognized the merits of Federal Regulation of banking and the economy. By that time, Detroit was gutted, American manufacturing lost to Asia, and community banks relegated to a even smaller voice in America.  

The period of 1980-2013 showed the biggest increase in Stock prices in history, because money was being concentrated on banking and capital markets, with more and more concentrations of wealth. But during the same period, farming, heartland manufacturing, production, retail and commercial businesses struggled, with more and more "mergers and consolidations", often paid for by "funny money", stock paper, and financial instruments issued on Wall Street.  Some companies became rich by buying corporations and liquidating their "real assets", laying off their workers, and then bankrupting them, leaving their communities without jobs. Companies such as Polaroid, Eastman Kodak, Chrysler, General Motors, and hundreds of others suffered the "rape and exploitation" of poor economic management and unscrupulous financial "Whiz Kids". During this same period millions of American farmers, manufacturers, industries, and retail companies simply disappeared in bankruptcy or ran to other nations.  

In 2013 the industrial base of America is still suffering from the tight economy policies of the Federal Reserve Bank of the 1980's. The old worn logic that inflation is a moral evil and that it is ok to destroy jobs in the name of fighting inflation is a long destroyed concept. If we keep unemployment from 5 to 7% and growth in GDP between 2 and 3%, we should not have a major problem with inflation.  But using the "fear" of inflation or the danger of a "cheaper dollar" has proved to be a false argument again and again. When the dollar has been held high, our industrial sectors have simply died and we have gradually lost production capacity.  

There is a difference between economic reality and economic illusion. During the Volker/Reagan era, we saw the nation's economy go into deep recession, while from 1982 to 1987 the value of Dow-Jones industrial average inflated by more than 230%. Yet real economic growth, on main street America totaled only 20%.  Economists who called this 20% a recovery, probably had stock that had more than doubled. The rest of industrial and working America was struggling to keep up after inflation.  The same thing happened during the Bernanke/Obama recession.  Stocks and bank profits, hit all time highs, with stock prices up and big bank profits in the billions. But unemployment, failures of companies, and Main Street continued to be in a strangle hold of recession from 2008-2012. Only in 2013 did jobs begin to come back, led by Houston, Texas and the booms of energy and shipping. Oil and natural gas production finally threw so much new production and liquidity into Houston, that it bypassed the banking system and went directly into new jobs and growth on Main street.

People abandoned their banks, because their banks had abandoned them, and went to private investors for capital and loans. The Houston boom stimulated activity in Dallas, San Antonio, Austin, and eventually Atlanta and Los Angeles. For the first time in recent history, pure "production" and "delivery" from the Texas oil and port markets, overwhelmed monopolistic "capital" strategies of the big banks and Wall Street entities.  North Dakota also boomed, because of new jobs and production of oil there, making it the fastest growing state, percentage wise, in the nation.

This brings us to a salient point. To truly grow an economy with substantial, sustained growth, a nation must "produce" something.  Food, oil, machinery, cars, computers, widgets of whatever. And ideally, it must produce enough to satisfy national demand, but to export and sell to other markets.  That is what China, Japan and Germany have excelled at. America in the battle with "capital" as wealth converted to a "service economy", and our nation has been weakened by that conversion. Because a service economy can only last, if there is true productive wealth creating a fundamental foundation.  But a productive economy, generates true new value and wealth. It makes towns grow, labor healthy, and true fundamental wealth available. It creates a positive balance of trade, as we export to other nations.  

As I see it, a conversion to "financial capital wealth" using the symbol of money as power, and interest rates on selling money the only source of income, is a dangerous conversion for a nation. Because the nation loses fundamental wealth. Switzerland has always been a "financial" power. But as it's huge watch making productive sector diminished, it's fundamental productive wealth declined, and Switzerland has had to rely on "old money", and tourist dollars to sustain its standard of living. Jobs and true "fundamental wealth" from goods produced in Switzerland declined when "banking" and big money gained control and Switzerland became more of a 'service economy'.

The Swiss learned that Germany, grew it's financial structure the old fashioned way. Not by OPM (other people's money), but by keeping a strong manufacturing and agricultural sector of production. That sector grew and sustains Germany as a productive society, the most productive in Europe...while other European nations have opted out to lower and lower productivity, Germany has become the "King" of Europe. China, began to displace Japan, as Japan's manufacturing sector suffered through a "tight money and high interest rate" banking period. During this time, China multiplied production and manufacturing, and it now has more that 15 times more money in it's international balance of trade account, than Germany. China has more than all of the European nations combined and more than 10 times that of the USA.  That means in simple terms, China has more money, more cash in the bank, more economic power than any nation on earth because of ever increasing fundamental production and manufacturing. 

Now that we have passed the two Bush eras of lowering taxes while increasing Federal Spending tenfold, only to see the Bush family become the nation's leading socialist in "W's" policy of "Federal bail outs of big banks" the Obama Administration has had to spend an enormous amount of energy and capital to clean up the mess and try to keep the nation from another "depression". The period of 2008 to 2012 is now being called the "GREAT RECESSION", and time will only tell what the long term damage to the U.S. economy will be.  A few things are certain.  While the USA was fighting to recover, China deftly stepped in as the world's most powerful player, using it's huge populations, low wages and a strictly controlled (regulated) economy to assert it's control over Asian markets.

China today is steadily moving into South America, Central Asia, Africa and positioning itself as a world leader. So the future world will see a few power blocks, including India (right behind China in growth and innovation), the Middle East (which is stunted in spite of oil wealth because of religious conflicts), Europe (a semi united state that with the exception of Germany may be relegated to becoming a cultural museum for the world), North America and South America.  All of these areas will generally combine in blocks of "East vs West", "North vs South" and "Islamic vs Christian vs Secular". 

The new world demands that balanced and informed leaders of the 'Global Generation' work together to create an international system to create stability for a global economy. This will require well balanced and conceived regulations on Central Banks.  The 'Global Generation' must eliminate religious wars and conflict. The "Global Generation" must find ways to eliminate destructive competition for world natural resources, energy, and precious metals.  We must find an "energy sustainable" system for the future and we must, most of all, find some ways to eliminate the need for money.

Because money, and the control thereof, represents power in this world of ours.  Somehow, money and finance, assets and control, must be balanced into a system which can allow international prosperity, security and peace, to fulfill the aspirations of every child and businessperson who has dreams to fulfill. This vision will require big thinkers, and men to perspective, wisdom and integrity.