Weekly Commentary

July 16, 2012

The Markets

Should the Federal Reserve raise interest rates to fire up the economy?

For the past few years, the Fed has been on a mission to lower rates as much as possible. The thinking is lower rates will spur economic growth by making it less costly for businesses and consumers to borrow money.

Unfortunately, it hasn't quite worked as planned.

Short-term interest rates are near zero and 30-year mortgages are at a record low, yet the economy is still just muddling along, according to Barron's. Now, some investment managers are saying the Fed should reverse course and raise interest rates.

Last week, prominent money manager David Einhorn went on CNBC and said, "I think having very low zero rates is depressing to people. I think it deprives savers of reasonable incomes, the ability to forecast a reasonable income, and it cuts down on consumption." He went on to say low rates drive up food and oil prices and lower standards of living.

Folks relying on a stream of income from their fixed investments can probably relate very well to what Einhorn is talking about. As recently as July 2007, $100,000 worth of 1-year Treasuries would have generated about $5,000 of annual income (a 5 percent yield), according to data from the Federal Reserve. Now, it would generate only about $200 (a 0.2 percent yield).

The Fed may be in a classic Catch-22, according to CNBC. With sluggish economic growth, it's certainly hard to justify a rate hike, yet, low rates are increasingly ineffective. CNBC says a growing number of analysts suggest the best course of action is to allow "the cash-rich private sector to sort out its own problems without the government's interference." However, they acknowledge it "likely would be painful, but could be the only sustainable path to recovery."

With the Fed on the record as saying they plan "to keep interest rates at their historically low range of 0 to 0.25 percent through late 2014," investors shouldn't expect the Fed to raise rates any time soon, according to Fox Business. Only time will tell if this low rate strategy is the right medicine for the economy.

Notes: S&P 500, DJ Global ex US, Gold, DJ-UBS Commodity Index returns exclude reinvested dividends (gold does not pay a dividend) and the three-, five-, and 10-year returns are annualized; the DJ Equity All REIT TR Index does include reinvested dividends and the three-, five-, and 10-year returns are annualized; and the 10-year Treasury Note is simply the yield at the close of the day on each of the historical time periods.

Sources: Yahoo! Finance, Barron's, djindexes.com, London Bullion Market Association.

Past performance is no guarantee of future results. Indices are unmanaged and cannot be invested into directly. N/A means not applicable.

HOW DO YOU TURN A PENNY INTO 1.25 BILLION DOLLARS? Sounds like a magic trick, right? Well, there's really no magic other than the law of large numbers.

Here's how it works and how it may benefit our economy.

A report from the Federal Highway Administration shows Americans traveled approximately 2.94 trillion miles in motor vehicles for the 12 months ending April 2012. Now, when you figure how many gallons of gas that burns up, you get a really big number! Moody's Economy.com chief economist Mark Zandi has done the math and, by his reckoning, each penny change in the price of a gallon of gas equates to, you guessed it, about $1.25 billion over the course of a year, as reported by CNBC.

With the wild swings we've seen in the price of gas, the savings - or cost - can add up quickly. A recent check with AAA showed the average price for a gallon of regular gas dropped by about $.25 over the past year. So, multiply $1.25 billion by 25 and you get, to quote Carl Sagan, "billions upon billions" of additional coin in consumer's pockets. And, that coin could fuel further growth in consumer spending.

You've heard the old saying, "A penny saved is a penny earned." Today, a few pennies saved on gas can add up to billions!

Weekly Focus - Did You Know...

There's about $1.1 trillion of US dollars in circulation today - an all-time record high. However, most of it is not "floating" around in everyday transactions. About 75 percent of the $1.1 trillion is in $100 bills which don't circulate much. On top of that, about 50 to 66 percent of U.S. cash is held abroad. Despite the proliferation of credit cards and debit cards, we still seem a long way away from a cashless society.

Source: CNNMoney