Why the Poor Stay Poor in America - The Cost of Borrowing Is Sky High

“ …Cards with the highest value rewards are often available only to the rich. First, you’ll need a credit score of at least 700 to qualify for a premium card. That eliminates half the country….Second, issuers consider your income and debt-to-income ratio, which can be used to disqualify card applicants with high credit scores.” The New York Times, March 4, 2023

(Thanks to Jan Peppler, PhD, who writes the fabulous newsletter, Finding Home for sending me this article!)

There are a good number of both esteemed economists and elected officials who disagree with the Federal Reserve’s decision to raise interest rates in an attempt to lower inflation. One major reason for this disagreement is that it translates to higher interest rates on credit cards, auto loans and mortgage loans. The cost of borrowing money goes up, which is exactly the point from the Federal Reserve’s view. The theory is if it costs more to borrow money, people will borrow less and thus buy less, resulting in decreased demand and then presumably, lower prices. Unfortunately, less borrowing and buying slows the economy, people lose their jobs…and eventually our economy sinks into a recession.

From a layperson’s perspective (that’s me), this choice to solve a problem is an incredibly long “end around”, when there are more direct ways to lower inflation, like price caps and taxes on excess profits.

Here’s how Robert Reich, former Secretary of Labor, economist, author of 18 books and professor of Public Policy at the University of California at Berkeley (not a layperson), believes we should handle inflation at the federal level:

Robert Reich @RBReich

Relying on the Fed to raise interest rates puts the burden of fighting inflation mostly on lower-wage workers, who are already hurting most from rising prices. Stop raising interest rates. Better solutions? A windfall profits tax, price controls, and antitrust enforcement.

1:31 AM ∙ Mar 21, 2023

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And it’s clear that those who are hurt the most from higher interest rates on loans are people who have to borrow to keep themselves afloat—not because they are purchasing luxury items, but rather charging the necessities on increasingly higher interest credit cards and taking a loan to buy a car, as two major examples. And with the increase in home prices and mortgage rates, the “American Dream” of home ownership is out of reach for most of us making average wages, so more and more Americans are at the mercy of landlord pricing. This article in The Stamford Advocate dated a few days ago, explains that not only are people carrying more debt this year than last, they are not paying it off each month and thus incurring higher interest rates: “46% of people are carrying debt from month to month, up from 39% a year ago, according to Bankrate.com, an online financial information site.” On a personal note, the interest rate on my beloved Apple card is 26.49%, and I’ve charged close to the full credit limit. I wish I could say my home and pockets are filled with amazing Apple products, but I used the card to charge my rent for two consecutive months. And I am only one of millions who are in this situation.

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An exchange from early March between Senator Elizabeth Warren and Jerome Powell, Chairman of the Federal Reserve, gives us a glimpse into how the Federal Reserve’s use of a single tool (interest rate adjustments) manipulates our economy to slam low and medium income earners, and doesn’t lower inflation all that much. And it also demonstrates how limited and ineffective it is to rely on simply raising interest rates to lower inflation.

According to a recent NerdWallet article dissecting the Federal Reserves’ current approach of raising interest rates, Kathryn Edwards, economist and professor at the Pardee RAND Graduate School said: The Fed’s approach “has the delicacy of a blunt ax…”. It may eventually, after years of interest rate hikes, get the job done, but it destroys everything in its path to reach only a modest result. The Federal Reserve has raised interest rates nine times since March 16, 2022, and inflation has been reduced from a high of approximately 8% to its current 6%. Given that the goal is an inflation rate of 2%, most experts agree there is a long way to go, and a lot of continued suffering for lower and middle income workers, the elderly and others on fixed incomes.

Let’s briefly explore the “premium reward” credit cards only accessible to the wealthy. Typically, those who qualify for these cards don’t make the banks money by paying exorbitant interest rates on balances carried over month-to-month or late fees, so how do the banks make up for the luxury perks offered on these cards? By the imposition of “interchange fees”, the money it costs for merchants to accept non-cash payments. According to the New York Times opinion piece quoted above:

Lower-income consumers are forced to pay higher prices on the goods they buy, but they rarely receive any benefit from rewards programs, according to the Federal Reserve, which has been tracking the distributional effects of card rewards. Its December 2022 report estimates an annual redistribution of $15 billion in rewards value from poorer people to richer people, from low-education people to highly educated people and from diverse communities to less diverse communities.

That is a brutal structure that according to the Federal Reserve’s own report, make the rich, richer and the poor, poorer.

To wrap up, let’s again watch Senator Warren as she eviscerates Jerome Powell’s plan to lower inflation at a Congressional hearing held last year, only a few months after the Federal Reserve first raised interest rates this inflation cycle.

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What are your thoughts on inflation and how the Federal Reserve is handling it? Are you paying interest on credit card debt? Enjoying luxurious credit card rewards? Please share your thoughts in the Comment Section below. And don’t forget to hit that “like” button and share this post if you’re so inclined. It helps!

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