What Happens When Interest Rates are Raised?

[Headhunter]

"Qualitative arguments to the contrary, the back-of-the-envelope numbers indicate that price inflation will not be sufficient to overcome the falling velocity of money and, therefore, even nominal GDP is unlikely to grow. It follows that the forecast Twelve Month Trailing earnings (GAAP adjusted by Standard and Poor) will unlikely show any growth on the year immediately preceding the financial meltdown. The forecast P/E ratio of 24.3X is therefore â??wildly optimisticâ?? in terms of historical benchmarks, given that high P/E ratios typically anticipate strong growth. The facts show that whilst the world economy may or may not bounce from its current low levels, even if it does bounce, the forecast earnings of $43.58 seems highly unlikely.

When investors finally come to understand that it is only in Peter Panâ??s Never Never Land that age and gravity can be defied, there will likely be a downward adjustment of P/E ratios to at least historically â??normalâ?? levels of 15X and perhaps as low as 10X.

In terms of the chart below, courtesy DecisionPoint.com, the most likely outcome is a fall in the S&P to around the 500 â?? 600 level â?? which is the 77 year trend line."

http://www.marketoracle.co.uk/Article13718.html

In English: stock prices are currently at a level reached during boom times. The earnings are just not there though. So the market will have another crash.

[LIFTICVSMAXIMVS]

[quote]Headhunter wrote:
LIFTICVSMAXIMVS wrote:
formerfatboy wrote:
LIFTICVSMAXIMVS wrote:
hedo wrote:
Rising interest rates will crush any sort of recovery in 2010-2011. This will lead to a pro business candidate being elected in 2012 that will slash tax rates and spending.

No. Rising interest rates will spawn the recovery: More saving, less spending.

Is this what you mean?

Rising interest rate will spawn a depression.
Depression will create a behavior of more saving, less spending.
More saving, less spending will spawn wealth creation.
Wealth Creation will lead to economic recovery.

Yes, in a sense. Rising interest rates would cause people to slow down their spending and save more. Whether it leads to a “depression” I cannot say that for sure. Some claim we are already in a depression – which is a slowdown of wealth creation.

Saving is the only way to create wealth because it allows investors a chance to risk in an entrepreneurial endeavor to bring about new goods and services – that is wealth creation. We don’t necessarily have to save a huge amount. The key is to not over consume – that is to say, don’t take on more debt than can be paid back.

Ah, but there’s the rub, Lifty – savings goes to hell when people don’t trust the currency. They see our currency being printed like napkins, knowing that such low rates as today had to come about because of a flood of new money.

The history of money is a fascinating topic, esp how the Romans absolutely despoiled their currency, wanting to continually spend, spend, spend. Once everyone gets wise, the country collapses into ruin and slaughter.

[/quote]
Which is why interest rates need to rise and bad debt needs to be liquidated.

Like you say, low interest rates will not cause people to save. And actually interest rates have to be low right now because banks are flushed with too much cash on the books. This inflation is coming home to roost whether we like it or not. Banks will not not loan it out. In fact banks are trying to come up with creative ways to get consumers to take on more debt. They might have to pay us to take out loans. Could you imagine that!?

The Fed should just take all the money back that is sitting still and allow interest rates to rise via market forces.

People would be forced to save whether they wanted to or not. And that would probably give some trust back to the dollar.