The Fed has increased interest rates. Several people have asked me what all the fuss is about. Can 0.25% make that much difference? My answer is yes.
First, there is no sign that this rate rise is needed. The US is growing, but hardly confidently. It has more inflation than we manage to create, but given the amount of money pumped into the economy, hardly any at all. And the risks surrounding its economy are enormous: stock and commodity markets both indicate serious downturn risk whilst in emerging economy banks the risk of default on dollar loans as QE funds dry up and refinancing of corporate loans looks to be getting harder appears to be significant, with major spillover risk. Nothing about any of that says a rate rise is needed.
Second, if this is signalling it is saying that the trend is up, and that means tougher lending and monetary climates ahead. That can only (unless the markets invert all previous experience) suggest lower lending and so reduced economic activity. In an economy that is far from overheating the need for that is hard to discern.
Third, as the main reserve currency, this signal on the dollar suggests that other central banks should be following. There is no other major reserve bank that needs to do so, or even can do so without massive risk. The UK has little inflation, and with falling commodity prices little chance of much of an upturn in inflation next year (a change in my expectation) and the euro and yen both face long term recessionary environments and deflation. The last thing they need is rate rises: increasingly negative rates are more likely. This then is a step no-one can follow without massive risk. So as a signal it fails.
Fourth, the domestic signal may also fail. If downturn is likely - and I think that as near certainty as it gets in economic terms - then this is a signal that will have to be reversed. That will show a weak Fed out of touch and out of control, which is not at all what the world needs.
So, why has it been done when it seems so bizarre to do it? This is the easy part to explain. Bankers want it. Higher rates represents the old 'normal' where they can enjoy higher margins on money on deposit. I cannot see any saver benefitting.
And economists want it: positive rates make them feel comfortable that monetary policy might still work when in practice it has been mostly dead as a tool of economic management since 2009.
And politicians want it: this is a sign of virility aimed at the grey vote who have some savings who are now such key players in elections.
In that case this is all posturing by people who should know better and for whom the increase will come before a necessary fall, or at best the creation of a new normal at the new rate, with no further upward movement to come. They will all look silly, at best, in due course, but will go hime for Christmas thinking that they have at last 'done something'.
The truth is, of course, they could have done something better. They could take direct fiscal action to reduce speculative lending. They could direct money to markets at risk. And they could have undertaken direct investment in the economy (that People's Quantitative Easing by any other name) with QE funds as they roll over to address the three issues of stagnant wages, significant poverty and failed infrastructure investment that plague the US economy. But instead they chose to appease bankers and the grey vote.
It's a mighty screwed up world when that's what happens.
All I can say is the next crisis really cannot go to waste like this one has done: next time it has to be different.
Thanks for reading this post.
You can share this post on social media of your choice by clicking these icons:
You can subscribe to this blog's daily email here.
And if you would like to support this blog you can, here:
Yellin sounded like another cloud cuckoo land voice as id Cameron crowing about 5.2% unemployment largely accounted for by poorly paid jobs/those hammered off benefits/underemployed/and a projected (by 2018) 1.25 million in full-time work relying on housing benefits.
Osborne crows about returning to ‘prosperity’ under these conditions? Many commentators agree with you, Richard, that the .25 is about having ‘something in the tool box’-meanwhile the pretence that there is a ‘normal’ world to return to goes on.
It is certainly difficult to avoid the observation that the Central Banks, led by the Fed, may well be about to repeat the same mistakes they made in the 1930’s at a similar point in the process.
However, it may even be worse than that. A chap called William Edstrom, who I’ve come across before and quoted on this site wrote an interesting piece in late October here:
http://www.counterpunch.org/2015/10/28/united-states-treasury-swap-spreads/
“In October 2008, something happened that had never happened before. The United States (US) Treasury 30 year bond interest rate swap spread went negative, below the interest rates being paid on US Treasury 30 year bonds.
The wall street “algos” (computer algorithms) hadn’t been programmed for that because it was considered to be like a law of nature that US Treasury bond interest rate swap spreads could never be lower than the actual interest rates being paid by US Treasury bonds.
Unless. The US government would soon be either bankrupt or no longer in existence.”
Edstrom goes on to observe that current negative rates of this kind on ten year US bonds indicating that:
“The consensus of bankers and hedge fund vultures is now that the US government will be either bankrupt (unable to pay it’s bills and unable to borrow any more money) by 2025 or the US government will no longer be in existence by the year 2025.”
With the negative rates currently operating on five year bonds bringing this date forward to 2023.
It would certainly be interesting to see what the same set of figures look like in the UK and Europe, along with a chart of what impact the 0.25% interest rate increase would have, if any, on the figures Edstrom is looking at.
Dave-the US can’t go bankrupt as it issues it’s own unpegged currency-even Greenspan pointed that out -a bankrupt US is an impossibility unless it uses accounting rules to tie itself in knots for the sake of corporate interests.
Unfortunately Simon what you and I think and see does not seem to carry a great deal of weight with decision makers.
As the author of this blog implies it is what the banks, the hedge fund managers and the like, think and see which tends to drive policy decisions. If these people interpret what their algorithms are telling them is that they might not get their money back interest rate rises and austerity to balance the books will dominate the agenda.
What I would consider to be my extremely limited knowledge in this field suggests that the reason the US unpegged dollar can currently sustain the steller levels and debt ratios which exist at present is largely down to the dollar’s status as the prime reserve currency. With key resources like oil being denominated and purchased in dollars this, as far as my limited understanding is aware, allows dollars to be constantly recycled to prop up the US debt. Little wonder that despite global warming oil dominates the agenda of both the US economy and what passes for the body politic’s agenda’s in foreign and domestic policy and approaches to climate change.
Whatever the process involved any system can break down should any of the operational variables change beyond the systems carrying capacity, disappear altogether, or some new variable occur which the system does not allow for. In this instance such an event could occur as a result of the dollar losing its current reserve currency status (variable ceasing to exist); the debt level going beyond system carrying capacity, eg rest of the world unable to recycle sufficient dollars to sustain the debt(catastrophic change in variable); or adoption of a technological breakthrough which makes oil use redundant (new variable).
The Edstrom article is yet another example of the “parallel universe” that has been created by global financialisation, which is nothing less than a gambling den for the rich and has divorced itself from the real world (until it all goes wrong).
The problems with unsustainable global debt have not gone away, they have just got bigger, and when the US government eventually has to admit defeat and monetise its national debt that may just be the end of a capitalism we know today which has been allowed to fester and mutate under the guise of “democracy”.
But it’s not yet clear what will replace it – probably a true financial dictatorship run from New York under the nightmare scenario model!
I think that you are right on the nose here Richard. When I heard it announced I though that it was ‘noses in the trough’ time again for the big boys.
0.25 for most ordinary savers with small pots of money is very small beer; for the big investor with their bigger balances, 0.25 is probably very nice indeed.
It’s an early Christmas present to the investor class.