Low Interest Rates May be Costly in the Future
Low Interest Rates May be Costly in the Future
According to an article in the national media, a graduate of Harvard masters of business administration was able to pay off his student loan with a balance of $91,000 in a span of seven months.
What’s interesting in the story is the MBA graduate was surprised that after two years of payments every month on his $101,000 loan, just about half of his total payments decreased the loan balance or principal. The other half was taken up by interest charges, most of which accrued during his stay in school.
However, the more important thing is that the story shows the role that interest rates play in our lives and our economy.
For instance, throughout the recession and our lengthened weak recovery, we have not understood the actual burden of our national debt due to very low interest rates. However, it is easy to understand that low interest rates can indicate less costly borrowing. Moreover, we have to be familiar with how financial markets work to know how our increasing national debt will make a predicament for our economy in the future.
While the economy is expanding slowly, our savings surpasses the total amount of business investment opportunities. Consequently, a significant amount of cash becomes available. That existing cash was further increased by the delay in the global economy and particularly by investors in search of safety from the financial crisis in Europe.
The outcome for the U.S. has been a flow of cash seeking to be exchanged for Treasury bonds. But since bonds become a debt payable in the future, their cost decreases when the interest rate increases. On the other hand, when interest rates are at their lowest, then bond prices or values are at their highest as well.
More than $5 trillion of Treasury bonds have been sold and their values will decrease as soon as the global economy starts to recover and interest rates start to increase. People holding those bonds will most likely want to sell them right away, but the result will be even higher interest rates.
Not only economists must worry about this dilemma but it also reminds us that interest rates are vital to us and our economy.
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