Let me explain myself.

There are two groups of bankers paying high rates right now.  One camp pays them because they have to do it.  They’re on the verge of going out of business and have to pay high rates in order for you to leave your money there.  As long as you’re FDIC insured, you should take advantage of these poor souls. 

The group that I want to deal with in this post is the banker who pays high rates because he wants to do so, not because he is desperate to keep your money. 

This group is exceedingly smart, forward thinking, and low-risk taking.  He’s paying rates on short term CD’s at current market rates.  That is, for CD’s with around 30-days to 2 year maturities, he’s paying somewhere between .5% to a little less than 2%, respectively.  That’s not how he’s being smart though. 

What the smart banker is doing is locking in long term CD money now in anticipation of substantially higher rates coming in the future.  He’s paying around 4% (which by the way isn’t really all that high of a rate compared to rates over the last 20+ years) on 5 year CD’s.  Right now, that CD is losing him money, but over time, he’ll make a killing on it. 

Here’s why:

With the Federal Reserve and the Federal Government already having promised, guaranteed, or directly put 11 trillion dollars into the economy, there is going to be inflation.  You cannot put that amount of money into our economy without devaluing our currency, i.e. causing substantial inflation. 

(Read Fed. Charman Bernanke’s latest comments on inflation here)

If words like inflation, devaluation, the mirage of the Federal Reserve, etc., don’t mean much to you, let’s put it in terms of something everybody understands: gas.

Everyone needs it, everyone wants it, and you have to use it almost every day.  Now, let’s say everyone had to drive as much as they do now with the car that they have right now, BUT there was only enough gas on earth for everyone to have three gallons per month.  The price of gas would be unbelievably high, right?  Gas would be VERY valuable. 

 Alright, now take that same scenario and let the oil countries produce so much for everyone to have one thousand gallons a month.  The price would be extremely low right?  It wouldn’t be nearly as valuable.   That second scenario is what is going to happen to the value of our dollar over time because there are just so many dollars available right now. 

When inflation hits, and it will, interest rates will naturally go up in line with how bad that inflation gets.  This means that bankers will have to pay you higher rates on your CD’s.  So right now, the smart banker is using his forsight and knowledge to pretend to be paying people a “high” interest rate on 5 year CD’s, all the while knowing that you’re being a fool for falling for his little trap. 

My point is: Before you just go after the highest rate, look at the longer term implications.  If something seems too good to be true, it probably is.  Bankers paying high rates on short term money are probably going out of business soon.  Those paying “higher” rates on long term money that locks you into a very long holding period are probably taking advantage of your ignorance about inflation. 

Remember, inflation runs somewhere between 2% and 3% per year in good years.  We’re about to enter a period of high inflation (think something similar to the late 1970′s and the Nixon/Carter years).  Do you really think that 4% on a 5 year CD is a great rate in light of the fact that just 12 months ago you were getting 5.35% on 1 and 2 year CD’s?  Do you really think that if prices at the grocery store are rising at 5-10% per year that you’ll be happy about basically losing money on your CD?  If you’re fine with all that, then by all means, get that 4% CD.  If that scenario scares you, put your money in something much shorter term and settle for the lower rates in anticipation of being able to get a much higher, inflation-adjusted rate in the fairly near future. 

If you don’t believe me when I say 4% is a historically very low interest rate, check out what rates on 6-month CD’s have done over time here.  Keep in mind these CD’s have terms 4.5 years shorter than what you’re locking in if you take that 4%, 5 year CD.

(For all you who care about political correctness, insert “she” in the smart banker references wherever you deem appropriate.)

Him: “You know, if the government just keeps handing money over to banks that do nothing but hoarde it and lose more money, we’re never going to get out of this…”

Me: “Well, believe it or not, banks are making a ton of loans still, and the bailout was necessary because of the huge amount of money that it would have taken for the FDIC to make good on its insurance promise.”

Him: “It wouldn’t have cost nearly as much for the FDIC to just shut down all the bad ones and let the good ones survive!”

Me: “Well, let’s just pretend that this bank went out of business, ok? You have a few CD’s with us that total about $50,000… and you’re fully FDIC insured. Sound right so far?

Him: “Yep”

Me: “Alright, so we have about 6,000 customers who are in a similar position as you…and we’re a very small bank, Agreed?”

Him: “Yep”

Me: “If we went out of business today, the FDIC would lose anywhere from 50 to 100 million dollars because of just us going out of business.”

Him: “That’s a lot of money!”

Me: “Right. Now if you think about a Bank of America or Citibank, they do business with something like 100 million people just like you… and are each about 100 times as big as we are. Can you imagine what the loss would be if they went under?”

Him: “Holy hell!”

Me: “And if they went out of business, do you think people would think their money was safe ANYwhere?”

Him: “No, I’d probably pull my money out and hide it under my mattress…”

Me: “That’s exactly why they had to bailout the system. To make sure you, and 100 million other people, didn’t do that exact thing.”

Him: “Oh… well i guess that makes a lot of sense.”