Chapter 234: Crisis Behind Prosperity

"Typically, an interest rate, like the 12% you have here, includes three components: the risk-free rate, the risk premium, and profit. The risk-free rate is relatively fixed, which ensures the safety of your funds."

"If we only consider the risk-free rate, assuming everyone can repay the loan with zero risk, and we assign a risk premium of zero and profit of zero, lending based solely on the risk-free rate means that if you lend out $100,000 now, ten years later, the total amount you receive in principal and interest will have the same purchasing power as $100,000 today."

Jim drew a cylinder on the notebook, with the largest portion at the bottom representing the risk-free rate. Then he continued:

"Do you see this proportion? The risk-free rate is the core foundation of money circulation. Because the risk premium varies based on the applicant's qualifications and past records, and the profit rate varies due to different goals of each bank. For example, commercial banks have a much higher profit margin than savings banks, so their rates will be higher in terms of profit."

"So what really affects the market, all people, all banks, all credit institutions, and all industries related to the lending market is this risk-free rate."

"So what is this risk-free rate?"

As Carter looked at the chart drawn by Jim, he pondered.

"You can consider government bonds. In reality, there is no truly risk-free rate, but government bonds issued by major economies can be considered virtually risk-free. Because the collateral behind government bonds is national taxation, for major countries, tax revenue is stable and immense, so there's almost no risk of default."

"Considering this point, have you noticed the problem?"

As Jim introduced this, he paused, prompting Carter to think.

"Just now you mentioned that the ten-year bond yields increased! Are you suggesting that this rate is not controlled by the Fed?!"

"That's right, but it's not absolute. Interest rates are cyclical indicators, including overnight rates, weekly rates, monthly rates, and even annual, ten-year, twenty-year..."

Jim nodded approvingly, partially affirming Carter's statement.

"As for the future, we're all making predictions. But how do we standardize those predictions? Even if we do, we might not agree with them, right?"

"The federal funds rate, controlled by the Fed, only affects daily rates. This is the current situation: 'The money is here with me, if you want to borrow, you have to follow my rules!' This is a rate fully controlled by the Fed, but in the long term, it's not possible!"

"For example, if the Fed says they want to set the ten-year loan rate at 8%, what's the use? Inflation is currently over 10% per year. That means the purchasing power of my money depreciates by around 9.1% each year. If your rate only gives me an 8% increase, why would I buy a product that I originally intended to use to maintain or increase its value?"

"These medium and long-term loan rates, also known as the LPR, are rates that the central bank cannot directly control. They're market-determined, but central banks can indirectly influence them. This is what I meant by your quantitative control!"

Quantitative control?

Before Carter could fully digest the previous content, Jim continued:

"On the eighth floor of the New York Fed headquarters, there's an office called the Fed Trading Desk. Their job is to control the open market. They closely monitor the government bond market, buying high-yield bonds and selling low-yield bonds to control the money supply. They discourage people from continuing to invest in speculative investments and encourage them to focus on the present. They encourage people to spend money on living or doing something productive."

"In short, it's to reduce the circulation of money in bonds and securities markets. This is called quantitative tightening, artificially influencing the economy. Following this line of thought, what do you think you're doing?"

"Interest on loans is the lowest in the entire state! Even in the whole country, you're encouraging locals to borrow quickly, massively increasing the currency circulation in the market."

"I know you made a fortune trading gold, but we never thought you would spend all your money here! A large amount of money that doesn't belong to Douglas has entered, increasing the money supply in the market. Not to mention the people you're attracting now."

As Jim spoke, his mind was buzzing.

"Three thousand households, over ten thousand people. Just in the housing market, you've brought in over a billion dollars in currency. All this money is excess currency! For Douglas or Pearson, if we analogize with the central bank, the money you've brought in that doesn't belong to Douglas is like you're increasing the currency supply and actively controlling this market, making it more active!"

"But you have to know, these methods, these strategies, can only stimulate or limit the economic development to a certain extent, and they don't fundamentally solve the problems in the economic system! Let me explain the joints here. First, these people who bought houses, did they borrow loans from the local city?"

"Yes."

Carter nodded, just about to say something when Jim asked again:

"At what interest rate? 16? 17? Or 18?"

"An average of about 17.1%."

"Alright, let's assume 17%. A loan of $40,000. In the first year, they need to pay $6,800 in interest, and then they need to borrow another $10,000 to buy your house, right? Based on your 12%, that's $1,200 in interest."

"Damn, it's not enough to repay! I'm only making $500 a month now, just enough for $6,000 a year if I don't eat or drink."

Carter exclaimed, suddenly realizing the problem.

"Got it? I spoke with them this morning. To be honest, you're lucky. The people who've come here now still have some savings and can temporarily hold on. They can put in some money themselves to keep the funds flowing. But what about consumption?"

"Assuming a family of four spends at least $400 a month, they only have $1,200 a year to repay the loan. Even the interest is not enough, they're just repaying the interest, putting in nearly $5,000 of their own money each year. How much spending power do they have left?"

"So, should I raise salaries? Or continue to increase job positions?"

Carter was shocked, realizing the accounts he hadn't carefully calculated before, only thinking about how he could make money. Then,

"Wait! If the pressure is so great, why would they choose to take out loans and move?"

"Why? Didn't I just say it? They were actually doing quite well in their local area, and the real poor people didn't come because they couldn't afford it! They couldn't afford to move into this house!"

Jim sighed, memories of the old friends from Alabama flooding back into his mind.

"Raising salaries or increasing job positions is necessary, but it's not urgent right now. If you want to raise salaries or increase job positions, you have to find more demand!"

"Indeed, you've already stimulated a lot of market demand, but this is never-ending!"

"After they finish this round of work, many times they'll face a situation where there's no work. At that time, forget about raising salaries; avoiding layoffs will be tough. Where will you find demand then? Or will you continue to initiate new projects to keep the cycle going? And most importantly, where will the money come from?"