Magazine article Insight on the News

Clinton's Economic Policies Are Creating a Dangerous Mix

Magazine article Insight on the News

Clinton's Economic Policies Are Creating a Dangerous Mix

Article excerpt

Will low interest rates come back to haunt us? Right now it is whoopee land for debtors, who can refinance their home mortgages at the lowest interest rates in many years. But for savers and investors, both big and small, whose living standards are dependent on their investment incomes, low interest rates are causing them to take greater risks with their wealth.

For many years, retirees with savings enjoyed high interest rates on safe, short-term investments such as certificates of deposit and money market funds. The combination of low inflation and slow economic growth has reduced the interest rate on these investments to a pittance. Many people are experiencing difficulty in adjusting to substantial reductions in their incomes and are turning to riskier investments in search of higher returns -- often without fully understanding the risk.

Low interest rates are a principal factor driving the stock market up. It is straightforward supply and demand. As bigger returns are sought and more money is shifted from low-paying certificates of deposit and money market funds into stocks, the stock market rises ever higher.

The problem for the investor is that it may be the inflow of money into stocks, rather than the underlying profitability of the companies or the outlook for the economy, that is keeping the market up. If the stock market gets too far ahead of the underlying fundamentals, the market drops, wiping out invested wealth.

This can't happen with bank CDs or money market funds. CDs are protected by federal deposit insurance, but their main safeness, like that of money market funds, comes from their short-term maturity. If interest rates go up, an investor is not locked in with a lower-yielding investment. Short-term investments can be rolled over when they come due to take advantage of the rise in rates.

This isn't true of long-term investments, such as 30-year Treasury bonds. The danger from investing in these bonds is not that the government might default, but that interest rates will go up. The minute interest rates go up, the prices of long-term bonds go down. To take advantage of the higher interest rates, investors would have to sell their bonds at a loss.

This loss can be substantial. By 1980, years of inflation had driven long-term interest rates up to double digits. …

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