The Investment U E-Letter: Issue # 248
Tuesday, June 17, 2003

Interest Rate Prediction… How Low Can They Go?
By Dr. Steve Sjuggerud, Chairman, Investment U

Interest rates are at the lowest levels in a half-century and rates seem to be accelerating lower every day

As I write, short-term interest rates are a measly 0.85%. Long-term interest rates are at an astoundingly low 3.16% (that’s 10-year U.S. government bonds). And even 30-year mortgages for you and me are now below 5% (so says www.bankrate.com). (Ten-year mortgages are at about 4.3%!)

Can rates keep sprinting lower? Can they even stay as low as they are now? And what should we do about it? Let’s consider each question

Interest Rate Prediction: Can Rates Keep Sprinting Lower?

Yes

You’ve probably never experienced interest rates this low before. So you probably won’t believe me when I tell you they could easily go much lower. But they can. Let me give an actual current example

In Japan, interest rates are about ZERO. It’s true. Short-term interest rates in Japan are as close to zero as you can get, at 0.01% right now. And even long-term rates (10-year government bonds) are only paying you 0.45% a year. That’s 45 cents on a $100 investment With rates that low, why even bother?

How much lower can rates go? Judging by Japan today, the answer is, “All the way, baby.”

Interest Rate Prediction: Can They Stay This Low For A While?

Yes, again

Over the 100 years from 1870 to 1970, the median long-term interest rate in the U.S. (on government bonds)was 3.39%. Looking at England, which has a longer data history, over the 250 years from 1715 to 1965, the median long-term interest rate was 3.37%.

I find it interesting how close these two numbers are - 3.39% and 3.37%, over such a long period of history. The first conclusion we might draw is that a long-term interest rate of about 3.4% might actually be about right, and we’re not far at all from that right now. Times like now, with seemingly low interest rates, are not strange at all throughout history or are they?

Interest Rate Prediction: What Should We Do About Today’s Low Rates?

There is a big fly in the ointment here Throughout most of financial history, we were on a gold standard (or something close to it). However, 30 years ago, we went off any semblance of a standard. The result on interest rates was dramatic. Without gold backing our dollars, people lost faith in the value of the money. Investors demanded high interest rates. And interest rates peaked over two decades ago at double-digit levels.

The last three decades are a new era in the States - completely paper money. And the history of paper monies is not particularly good. It may end badly, with much higher interest rates. But it’s not smart to bet on interest rates. Who’d have bet on 3% interest rates a few years ago? Nobody. It’s much smarter and safer to stick with what we know, not make an interest rate prediction on loose information.

There are a few obvious things you can do based on what we know

1) Refinance your home.

If you haven’t already done so, rates below 5% are extraordinarily attractive and should be taken advantage of. Visit the independent site www.bankrate.com for details and a refinancing calculator to see if it’s right for you.

2) Change your thinking from “Building up a million-dollar-plus nest egg” to “How am I going to do better than 3% a year in income?”

A million-dollar nest egg that pays 1% a year in interest isn’t enough to even pay your health bills, much less your living expenses, in retirement. (I’m working on a book with Van Tharp called Safe Strategies for Financial Freedom that will cover achieving financial freedom in detail. Hopefully it will be out by Christmas.)

3) Own gold in some form.

You pick it, whatever you’re comfortable with gold, gold coins, gold shares, whatever. Our government has stated its goal of printing money, which should drive gold higher. And when interest rates are extremely low, gold can do well. Since gold pays no interest, when rates are high, gold is unattractive. However, when rates are extremely low, gold is more attractive than paper money.

A less obvious thing to do is to NOT bet on higher interest rates

Just because you saw high rates two decades ago does not mean you’ll see higher rates again immediately. Rates could trend down for a long time (a la Japan) - crushing your bet - before they turn up. Nobody knows the future, and it’s foolish to attempt an interest rate prediction. Don’t assume that interest rates have to go up immediately.

Interest rates can stay low for a long time. They have been low throughout most of history. And they can go even lower, as Japan (with interest rates near zero) attests.

In sum, yes rates can stay low. Refinance, if you haven’t. Change your thinking about retirement. And own some gold.

Today’s IU Cribsheet

• Above I talk about the importance of owning gold in some form in light of the interest-rate slide. For a good introduction to buying and holding gold stocks, check out Investment U E-Letter #234: “The Basics of Gold Stock Investing.” It’ll help you get started.

Good Investing,

Steve

P.S., Now and then I like to go back to historical articles from the Investment U Archives and update them to offer a perspective over time. Here are a few more recent articles on the topic of interest rates:

• Interest Rate ForecastThe World’s Best Prediction for 2005 Will Surprise You
• US Interest Rate ProjectionsHow To Not Predict Interest Rates

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