How the Interest Rate Influences the Wealth Gap in America

By Hayden Kan

Since the 19th century, most of our activities such as shopping, living and investing are led by interest rate, a fee for borrowing money from financial institutions or banks. When the economy worsens and economic growth stagnates, banks will lower their interest rates to encourage people to borrow money because the cost of borrowing is so much less. This action can kick-start a weak economy because low interest rate urges traders and customers to make more transactions . However, in order to increase the rate of the economy growth, merchants or customers need a large sum of capital to support it, so they can use leveraging during trading, which can help them to earn a higher profit for their next trade. A great way to achieve this is the low interest rate, therefore businessmen and customers can borrow a larger sum of money to purchase and sell goods and services. Unfortunately, low interest rate can’t last forever because it will speed up the process of inflation and will weaken banks’ financial structure. That’s why banks will tighten their interest rate at some situations. It sounds reasonable because this can curtail the number of approving new loans to people who don’t really need extra money and diminish the pressure of keeping up with the inflation rate on general public themselves. However, banks are applying this tactic as a shortcut to gain and concentrate properties and wealth for themselves.

Low interest rates are tempting to businessmen and also, teenagers and people with poor credit. At this point, you may ask, “Why would the banks lend money to people who have poor credit, which is a very big risk?” The answer is simple, debt is money. From the graph below, “Percent of Assets Held by Wealth Class in the United States in 2007” by Wolff, it shows two major points about the wealth distribution, which is the disparity of possession of assets of each social class between the wealthier class and the lower income class.

 Assets own by the top 1% are almost equal to the debt on the lower income population. Also, the top 1% and the better off 90-99% are major investors in the market. They won’t waste time on saving money in bank, they buy securities and stocks instead. It means that what we are doing is providing decent lives for the richest in the USA while they are causing financial crisis for us. Besides that, since the top 1% is the major players in the financial market,  their influence is extremely vast. In this article, “Wealth Inequality” from inequality.org mentions the situation of the inequality of wealth in the US and ratio of the stocks own by Americans. While the top 1% owns 38.2% of shares in the stock market, the combine of stocks own by the bottom 60% to 80-90 percentile is only 18.8%. The disparity of stocks ownership between the richest and regular US citizens is distinctively wide and abnormal, which make investors like our parents have literally no major influence to the market at all.

Return to the problem of the interest rate, although there is no doubt that lending has positive effects on trading and manufacturing, there is a major fault in the system, which is the interest rate. When a person is borrowing money from a bank, there is an agreement on paying back the principal with a certain amount of interest as a service fee and promise on the loan. The problem is, the “interest” does not exist initially. The system will come to a halt eventually when there is no extra cash to fill up the interest.  So, in order to keep this system functioning, central banks need to print more money to postpone the deadline of the collapsing banking system. However, when anything becomes too readily available, its price will drop. This will cause inflation. From the graph, “Inflation and Interest Rates” by ONS Bank of England it is clear that most of the time,  when interest rates are high, inflation rates will stay lower than the interest rate. That means when the interest rate is unaffordable for borrowers, it can frighten them and diminish their interest in borrowing forcing borrowers to rethink their need for cash, their motivations for spending and their financial plans.

                      

High interest rates can definitely reduce the risk of having a catastrophe in the debilitated banking system due to the decreasing demand on loans. However, it will, nevertheless, defer the progress of any business activities by adding costs and expenses on both companies and customers themselves. In this case, companies will be likely to search for alternatives to minimize their cost and remain competitive. Outsourcing is their answer. Since the high interest rate is not affecting other developing countries and these countries have a huge army of low paid workers, enterprises build factories and offices in these new territories for keeping their cost low. Beside lowering the cost and remaining competitive, outsourcing can also create jobs in developing countries like China, Vietnam, Cambodia and India.

However, this makes the basic level and the lower middle class lose jobs in the State. An article, “ 4 Ways Outsourcing Damages Industry ”, by  Angie Mohr from investopedia describes, “ Jobs that move offshore often do not come back. The lower wages and operating costs, plus the simpler administrative requirements in countries such as India and Russia, make operating in those countries cheaper and easier. Without new jobs being created in America, unemployment rises and a higher base unemployment rate becomes the norm. It could be decades before developing countries reach their saturation point and wages are driven higher. In the meantime, more American workers are out of work with few prospects of landing a job”, which means since jobs have been moved out from America, it is not going to come back in an eon. Also, when other countries’ currencies are lower the the dollar, it is tempting for companies to move production lines and customer servicer countries’ currencies and salaries are  centres to these developing countries. These movements can also lower US  workers’ skills because there isn’t any place for them to learn and practice their skill and knowledge.

It is important to realise that interest rate has a substantial effects to our daily life that it should not be sneezed at. It cannot be denied that low interest can benefit the public and businesses, however we need to learn how to adjust our spending plans and the interest rate.

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