The Interest Rate Fallacy

Here’s the most basic of finance/economic questions: What do low rates represent? The vast majority will answer “money is cheap and easily available”, or something to that effect.

But what if the opposite is true? How would your understanding of markets and the economy change?

Why Are Interest Rates So Low? What You Need To Know 1

Milton Friedman's Interest Rate Fallacy highlights low rates as evidence that money supply is tight rather than the other way round as commonly believed

According to Milton Friedman, low rates = not enough money  and high rates = too much money.

What?!

But how?

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Change How You Think About Rate Cuts & Hikes Now!

Markets have a Pavlovian bullish reaction to Fed rate cuts but is this justified?

The Fed just cut rates by 25 basis points, BUY BUY BUY! Fed cuts rates = buy equities might be the most Pavlovian response conditioned into market participants in modern history.

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Why Are Interest Rates So Low? What You Need To Know 2

Milton Friedman's Interest Rate Fallacy highlights low rates as evidence that money supply is tight rather than the other way round as commonly believed

What else is in an interest rate?

We have already seen how the interest rate fallacy plays out when people only see rates as a function of central bank policy, neglecting the fact that borrower’s perceptions matter as well.

But what about how lenders see things?

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A New Perspective On Low Rates – Low Loan Demand! 1

Real yields remain negative in the USA

Earnings season is upon us again. While this is not something that is typically considered to be “macro”, everything is connected, and more often than not micro and macro factors affect each other.

In the case of 2Q earnings, this is best exemplified by Wall Street banks’ struggle with loan growth. Or rather, the lack of it.

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A New Perspective On Low Rates – Low Loan Demand! 2

Milton Friedman's Interest Rate Fallacy highlights low rates as evidence that money supply is tight rather than the other way round as commonly believed

Recognizing that loan growth is weak even though rates are at historic lows expands the list of possible causes.

Instead of banks’ simple explanation of demand for loans being low, which is the equivalent of blaming consumers and businesses for not wanting loans, we can see that there are other ways of looking at the situation.

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