If You Want to Understand the Economy…

… follow the real interest rate. The nominal rate, what banks and other lenders quote, is only part of the story. Subtract the rate of inflation from that rate and what you have left is the real interest rate. The real interest rate controls the availability of money to borrow, the strength of our currency, our balance of trade, and the severity of the national debt.

The real interest rate also measures the rate at which income disparity is growing. In simpler terms, the higher the real interest rate, the faster the middle class disappears. While we may look at the real interest rate as it pertains to the prime lending rate or the interbank lending rate (also known as the Federal Funds Rate, in case you’re in AP Economics) and see a very low real interest rate, those rates don’t apply to the poor and the middle class. They’re paying the real interest rate as it pertains to credit cards and consumer loans, and those rates are quite high. They’re higher than they used to be in the 1970s, which explains why the middle class has been on the run since that decade.

Even with a very low real interest rate for one and all, the money still flows from borrowers to lenders and the income/wealth gap continues to widen. Whatever other benefits borrowing may provide, the iron rule is that it will enrich the lender and impoverish the borrower, unless the borrower can pass his costs on to his customers via prices. Therefore, borrowing with interest will further impoverish the poor as sure as the moon goes around the earth.

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