With the Federal Reserve's surprise half-point cut to the fed funds rate last week, investors and consumers may have breathed a sigh of relief expecting the continued low interest rates we have grown accustomed to in the past several years.
Low interest rates are a good thing for those with credit card debt or variable-interest-rate mortgages. But if recent
comments by former Fed Chairman Alan Greenspan are any indication, these latest interest rate moves may very well be the calm before the storm.
Greenspan said that globalization kept inflation under control by keeping wages low while he was in charge of the Fed, but that effect can't last. Developing countries like China will see price pressures and higher wages, as the flow of people into the work force from farms to factories begins to slow.
These inflationary trends will have a global impact. Eventually, Greenspan believes that consumers should expect double-digit interest rates -- something the U.S. hasn't seen since the 1980s.
Greenspan isn't alone in this opinion. While inflation isn't as much of a concern to the Fed over the short term as confidence in themarket due to the subprime mortgage problems,
other economists believethat inflation will be a concern for the Fed over a five-yearperiod.
Understanding that economic forces will likely bring about higher inflation, and taking steps to prepare yourself for double-digit interest rates will allow you to lessen the pain and possibly even profit from the event. Here is what you should be doing:
Pay off credit card debt
: You should be doing this no matter what, but if double-digit interest rates will be coming in the near future, it is even more essential. If you have a balance on your credit card, it's time to pay off that debt as soon as possible. As interest rates rise, so will the interest rate that you must pay on the money you borrowed from the credit card company.
If you think that you are safe because you have a "fixed-interest-rate" credit card, you will be in for a terrible surprise. A fixed interest rate with a credit card company doesn't mean the interest rate is fixed at that rate forever. The fine print allows the lender to increase the rate, although it is not automatic as with a variable-rate credit card. If interest rates begin to rise, you can be sure that your fixed rate will also increase. Your only defense against the increasing interest rates is to not have any credit card debt.
Lock in interest rates
: If you have a variable-rate mortgage, you should consider refinancing and lock in a low, fixed rate. Locking in a fixed rate will mean paying a higher rate than you could get with a variable-rate loan, but in the long run, it will save you a lot of money. If interest rates hit double-digits, you'll still be paying that same lower, single-digit fixed rate, while others with variable interest rate loans will be paying double-digit interest.
Consider delaying loan prepayments
: If you have a fixed-rate mortgage or student loans that charge around 7% interest, you may have been paying them off early. If you can earn only 5% in the bank, paying off a 7% loan may make more financial sense. But if interest rates do increase to double digits in the next few years, you may want to have that money available for investment purposes, and the money that you paid toward these loans won't be accessible.
Save as much as you can
: Some may advise that you should spend your money when interest rates are rising, because a dollar today will be worth more than a dollar tomorrow. This advice is based on the assumption that inflation will continue and interest rates will remain high for a long period of time. If interest rates follow the 1980s scenario, however, they will remain in double-digit territory only for a short period of time -- something Greenspan predicts this time around.
: If rates hit double digits, you'll want to lock your money into long-term investments that will pay you high rates of return for years to come. Don't overlook CDs. When interest rates are high, CDs will also be paying a high rate. The longest CD term at your local bank is usually 10 years, but
brokered CDs can have terms that last up to 20 years. Make sure to read the fine print to ensure they do not come with a call feature.
Start planning now. If double-digit interest rates are on the horizon, there will likely be a lot of panic, doomsday talk and conjecture. It will seem that there is no end in sight. By preparing early and realizing high interest rates will likely be a short-term occurrence, you will be better positioned to weather the storm.
Jeffrey Strain has been a freelance personal finance writer for the past 10 years helping people save money and get their finances in order. He currently owns and runs SavingAdvice.com.