By Morton Marcus
Snail Smith’s real name is Stanley, but his contorted windup and slow pitches gave him the nickname, Snail, during his short baseball career.
“What?” Snail asked the word slowly but clearly said.
“What what?” I responded.
“What should a person do about it?” Snail said.
“It being what?” I asked.
“Money,” he said. “What should a person do about money? Particularly if they are going up.”
“What’s going up?” I was getting confused.
“Interest rates,” he asserted.
“Interest rates are holding fairly steady,” I said. “Thanks to the perhaps mistaken policy of the Federal Reserve, interest rates are virtually guaranteed not to rise until 2015.”
“But if they do, what do you do with it?” Snail asked again. “Where do you put it? Different economists have different ideas.”
“Right,” I said. “Some economists will tell you that the stock market will fall if interest rates rise. What they mean is that the price of any particular stock will decline unless the company can raise its dividend rate so that the yield on the stock maintains its risk differential vs. the market interest rate.”
“You understand what you just said?” Snail asked.
“Yes, imperfectly, but yes,” I confessed. “Bonds are similar. If interest rates rise, the fixed interest payment on a bond is less attractive and the price of the bond declines.”
“So bonds and stocks both lose value when interest rates rise,” Snail said.
“More or less,” I said cautiously. “Each firm and each bond offering is different, and you can only expect a general tendency of movement in prices. Plus, if you hold a bond to maturity, its face value does not change and your capital is protected. Then too, stocks can rebound quickly, as we have seen, with changes in expectations about economic conditions.”
“How about gold?” Snail asked.
“Sterile,” I sneered my best economist sneer. “Gold itself pays no dividends or interest. Its basic value rests on the costs of production and the demand for gold in industry and fashion. Then there is the speculative demand for gold, a factor based on fluctuations in fear about inflation and the value of money itself.”
“Will higher interest rates mean higher commodity prices for copper and corn and such?” Snail wanted to know. “Should I put my money there to protect against inflation?”
“What’s this concern with inflation?” I said.
“If interest rates rise, won’t prices in general rise giving us inflation, a decline in the value of money?” Snail said.
“Maybe,” I said. “Modest increases in interest rates do not necessarily bring about inflation or deflation. Much depends on the fundamental factors underlying demand and supply of goods and services in the economy.”
“You know,” Snail said, “In baseball some guys threw a pitch that was hard to hit. It twisted and turned, and we called those guys what I must call you, “Screwball.”
Morton J. Marcus is an economist, writer and speaker formerly with the Kelley School of Business at Indiana University. He can be reached at firstname.lastname@example.org.