Economic inequality is made worse by low interest rates as those rates increase asset prices since buyers of assets will use the low rate loans for purchasing assets.
You can probably stop reading there and understand the problem around fighting economic inequality. I hope you'll continue as we run through a case study. General information we'll need for this is that assets are owned by wealthier people. As long as we agree on that, lets see how a wealthy person's net worth increases thanks to low income rates.
Wealthy person 1 (WP1) buys an apartment building. The building makes $100,000 per year and they buy it for $1,000,000 in 2006. The capitalization rate for the property was 10%. This is a simple calculation of Net Operating Income (NOI) divided by asset value.
The key understanding is WHY was the cap rate at 10%. The cap rate is generally slightly above the loan rate for the properties, so a loan rate at the time might be 7-8%.
Lets say loan rates drop to 5%, the new cap rate will likely be around 7%. Lets check in on WP1 and see how they're doing with the new rates. Also, lets pretend everything is the same, WP1 did nothing to improve the property or the income it produces. Here's our new calculation
$100,000/.07 = $1,428,571 of asset value. WP1 saw a 43% increase in their net worth through the interest rate decline. They make no additional income with the property, but they are substantially wealthier than the non-wealthy people who don't own these assets.
Now we've come to a point in 2020 where we have an economic crisis and the Federal reserve has lowered rates to 0%. Many commercial loan rates are based on a simple formula, Prime rate + a designated percentage. For example, Prime +1% means the WSJ Prime rate +1% will be the loan rate. How is the WSJ Prime rate created? Simple. It's the Federal Funds Rate +3%. Federal reserve lowered the federal funds rate to 0% on March 16. 2020 (https://www.federalreserve.gov/monetarypolicy/openmarket.htm). Prime +1 (meaning a 4% loan in March, 2020) is a commercial loan I've received recently which is why I'm choosing it for this example.
Lets check in on WP1 with the new rates. A 4% loan likely means a CAP rate of 5.5%. Again, this lazy investor did nothing to increase income or property value.
$100,000/.055 = $1,818,181 of asset value. They bought the building for $1,000,000, it's now worth $1,818,181, an 82% gain. This of course is overly simplistic, they also gained with annual income the property provides (the $100,000), used some of that money to replay the loans we've been discussing, etc.
The point is, all other things being equal, low interest rates mean increased asset values and greater inequality. Some choices you can make from this understanding, is do you want to play this game too? what happens now that we're at 0%, is there room for more gains via a Negative Interest Rate Policy (commonly NIRP)?
I don't have answers on what you should do and you shouldn't be taking advice on personal actions from blogs/sites/celebrities/etc anyway. Learn about how things work and think for yourself, you might be wrong but at least you made the decision and can learn from the wrong decision as well. Good Luck Everyone!
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