Can you lend me $100 please? I promise that I’ll pay you back in 10 year’s time. How does that sound so far?
Did you ask what the rate of interest would be? Oh, that would be zero. It’s an interest-free loan. I’m a triple-A kind of guy. I’m good for the money. Just ask anyone.
By the way, the annual inflation rate could be 2% or perhaps more, which means that by the time I repay the loan, the $100 you receive might only buy you $81.70 worth of stuff.
So, do we have a deal?
It stinks, doesn’t it? But that it precisely what the US Federal Reserve is planning to do.
It is called AIT or average inflation targeting. Essentially, the Fed aims to boost average inflation above a 2% target, whilst keeping interest rates ultra-low for years to boost employment.
The two key words are “average” and “target”.
Currently, the US inflation rate is 1%. So, to achieve an average inflation target rate of 2%, consumer prices would need to rise faster than 3%. That is just primary-school arithmetic. So, even if the inflation rate should rise to 3%, 4%, or maybe more, the Fed would still keep interest rates at near zero.
What’s more, the longer that the inflation rate remains at 1%, the faster prices would need to rise subsequently for the average inflation target to be reached. That’s how averages work.
And all the while, the Fed will stick to its zero interest-rate policy. Incidentally, the “unemployment” argument that the Fed is touting, is a red herring.
What is really at stake is the huge amount of debt that the US government has taken on. It is now more than 100% of the country’s annual economic output….
…. It is not the only country that is shouldering a hefty debt burden. Others in the diabolical-debt club include Japan, the Eurozone, France, Italy, Canada, and Spain.
The Fed’s ruse is nothing out of the ordinary, though. It’s just that it is now more explicit, whereas before it used to be more subtle. “Financial repression” has been around for a long time. It’s great when you can get away with it.
It was most evident in the aftermath of the great financial crisis, when interest rates were driven to near-zero. At that time it helped to stabilise the banks. And here we are again.
It’s really bad news for savers. It’s dreadful news for people who are about to retire. But not if we are smart.
From an investor’s perspective, our best way to achieve a real and decent return on our money is to build a diversified portfolio of shares, and to stay invested at all times. It is not risk-free….
…. But investing is only risky if you don’t know what you are investing in.
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Disclosure: David Kuo does not own shares in any companies mentioned.