NCPA - National Center for Policy Analysis


June 13, 2007

The most important price in the American economy is not the price of oil, computer chips, wheat or cars.  It's the price of money -- interest rates.  When rates move, they ultimately affect the price of almost everything else, says columnist Robert J. Samuelson.

The economic expansion, both in America and the rest of the world, has rested on a foundation of abundant credit:

  • In the 1980s, mortgage interest rates averaged 10.9 percent; after inflation, the "real" rate was a hefty 7.2 percent.
  • During the decade, home prices rose a meager 1 percent beyond overall inflation.
  • Since then, mortgage rates have dropped sharply; from 2000 to 2006, they averaged 6.5 percent, and after inflation only 4.2 percent.
  • The result -- existing-home prices rose 29 percent more than overall inflation from 2000 to 2006.

It's not just real estate.  Low interest rates have fueled the private equity bonanza, says Samuelson:

  • In 2006, private equity buyouts of U.S. firms totaled $375 billion; some well-known firms "taken private" included Univision and Harrah's.
  • Similarly, low rates enabled governments and companies in developing countries to borrow huge amounts; from 2005 to 2007, their borrowing will total about $900 billion, says the Institute of International Finance.

But now rates are edging up, as credit tightens.  As the price of money increases, borrowing and the economy might weaken.  The deep slump in housing could worsen.  But this grim fate is hardly preordained, says Samuelson. Indeed, credit is still ample, just less so than a few months ago.  Aside from subprime mortgages, delinquencies on other bonds and loans remain low, as do interest rate "spreads" -- the gap between rates on safe and risky loans.

Source: Robert J. Samuelson, "The End Of Cheap Credit?" Washington Post, June 13, 2007.

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