RealTime IT News

Cash Loses Its Luster

They say cash is king in a bear market, but its crown sure has been getting tarnished lately.

That's because real interest rates in the U.S. are hovering around zero for the first time since 1993.

With the CPI at 2.7%, and the Fed funds rate at 3% and the discount rate at 2.5%, the cash that investors are holding is losing value, although admittedly it's not faring as badly as stocks have in recent weeks.

In the week ending Tuesday, the average yield on taxable money-market funds fell to a record low of 2.55%. The 0.43% drop was the largest ever, according to iMoneyNet.

With the CPI at 2.7% and money markets paying an average of 2.55% - before taxes - even cash has started to take a beating from this 18-month bear market.

And the Fed - which had an unofficial zero interest rate policy in the days after the September 11 terrorist attacks as it flooded the system with liquidity - could make the policy official next Tuesday, when it is widely expected to cut interest rates by another 50 basis points.

The CPI could fall in the wake of the terrorist attacks; it's likely to experience at least a one-month drop because of the sharp decline in oil prices. But in an economy already hovering dangerously close to deflation, with commodity prices hovering about 10% above 30-year lows, substantial further declines in the CPI would be a negative. Massive Fed rate cuts and liquidity have so far failed to reverse the economic slide, making the current situation all alone in history with the Fed of 1929-1930. With personal and corporate debt running at record levels - and early evidence that consumers are paying off that debt rather than adding to it - monetary policy is not likely to have the effect it once did.

For investors, the result could be a changed environment going forward. Stocks with steady earnings and high yields are likely to be in favor. Gold, which has historically done well in a zero-interest rate environment, will likely continue to do well. And companies that are dependent on the corporate bond market for continued funding could suffer, since that market has once again seized up. Low real interest rates could even hurt companies with high cash levels, such as Microsoft and Cisco , because their interest income will likely suffer.

But one thing is for sure; cash is no longer what it once was.