The Question of the Century? Will Janet Yellen be able to raise interest rates?
Will US Interest Rates Rise?
The question is a simple one: Can the Federal Reserve raise interest rates? If so when?
The Federal Reserve can raise rates at any time, they certainly have the legal authority to do so, but the question is what happens next? What happens if they raise rates under the current state of the economy?
A few notes before we get started.
Firstly we should consider that Janet Yellen has inherited the condition of the economy and can only try to keep it from collapsing with what she has at her disposal. She is really not at fault for what she has inherited, any more than was Obama for what he inherited from the previous administration. The Expansion of the period between the year 2000 and the collapse of 2008 had left the economy in a highly dynamic, highly unstable condition. Both Obama and Yellen had in reality limited options no matter what is said. Much of their combined actions were constrained by the nature of the economy as they had inherited it from their predecessors.
With that said what we should understand and make quite clear is that the Federal Reserve as it stands now can only raise rates if the economy of the world were to actually begin to “heat” up. That is if only prices began to rise universally around the globe. That would almost certainly involve a rapid increase in the price of commodities. However a rapid rise in the price of commodities would not be conducive to a stable economy so what the Federal reserve would be looking for would be a “gentle” rise in prices. But a gentle rise in prices would require the Federal Reserve to hold off on any increase until the economy actually did heat up. That could take quite awhile and be more a matter of chance than something stable and predictable and would of necessity involve taking a guess as to what the economy is going to do. Unfortunately this would not be conducive to a rational, consistent Fed policy emerging for a long period. The only certainty, or near certainty is the economy we have now, at this moment.
The truth is that if the Fed were to try to raise rates with the way the economy is now, there will most likely be very serious repercussions. For all the talk of a “recovering” U.S. economy, the truth seems to be that the recovery is piecemeal and rather unsteady. Yes there seem to be more jobs created, but there are questions as to who exactly is hiring, and who exactly is getting hired. Any increase in credit costs could well see a drop in hiring as it becomes harder to maintain profitability. Although it is true a stronger dollar should be better for people, since they can buy more with their dollar, the problem is that there is already too much money out there and prices may well oscillate wildly even if an attempt to dry up the excess money available were undertaken. Certainly, there is no easy formula between a stronger dollar and the employment picture. A stronger dollar can have potentially adverse effects on employment which would serve as a headwind against such a policy.
There are also serious questions about the strength of the dollar and how that will affect the general atmosphere of the global economy. A too strong dollar would mean that our trade deficit simply increases, something we really cannot afford having now some thirty years of deficits behind us and being seriously indebted.
There are also concerns about dollar denominated loans made overseas. These would wind up costing foreign borrowers more, and unless U.S. internal business activity were to increase while increasing American imports that served to ignite an increase in global economic demand, there would be serious doubts about the ability of foreign borrowers to pay off such loans. The structure of the Global Economy relies too heavily on American internal activity to create that global demand exclusive to the domestic U.S. activity. That is to say that because of the structure of the Global Economy as it is today, it’s unlikely that we are going to see a global demand surge that is independent of the United States. Failing that would leave foreign borrowers looking for ways to pay back trillions of dollars borrowed from American banks should the dollar continue to surge in relative value.
Add to this the oil plunge, which is quite serious in itself since the energy industry is the most powerful industry in the United States economy and its velocity affects just about everything other aspect of the economy. It is one thing to say that there will be money left over for “other things” due to the drop in fuel prices for the average consumer, but it is another when considering that most people will not of necessity go out and spend whatever money they save from the oil price plunge. On the other hand, the decrease in revenue from the price drop of oil will severely affect large parts of both the national economy and international economy since the velocity and demand draw created by the energy industry is ubiquitous and universal in influence. We can also add to this the cost of loans taken out by the fracturing industry and the oil exploration industry which is now struggling due to the low price of oil. At this time oil production and exploration is expensive and the present price of oil is not going to support either of these pursuits. Therefore we are going to see a severe contraction in fuel availability eventually and a severe increase in relative price. These energy related constraints will add to the general economic headwinds.
If the dollar strengthens oil prices will probably drop even further, along with other commodity prices. Resources and their extraction and processing have been among the best performing sectors of the past ten to twelve years and their diminution will only make things more difficult.
So for these reasons we see some very serious repercussions arising from any long lasting attempt to make the dollar stronger. But there is yet a better reason to doubt the ability of the Fed to raise rates without a negative impact: the U.S. debt.
The United States, and the Federal Reserve itself have gigantic debts outstanding. Cities, and states have large outstanding debts. The corporate world itself has huge debts pending. And personal debt is also beginning to rise. For as long as federal reserve interest rates are near zero, there will be no difficulty maintaining these debts. But the second interest rates, or inflation rise, the danger will increase dramatically. Either the government will have to borrow ever more money, which will further drain the economy, or it will have to begin downsizing the debt through measures of austerity-similar to what Greece has been experiencing. Corporate bonds would also be immediately affected also and corporations would eventually face the same problem as the government, either borrow at ever growing rates, or contract, and this would begin to work severely against the economy. The effect is probably going to be sudden no matter how careful the Federal Reserve might try to be. Either way, the news will not be good. This will in both cases lead to higher taxes, higher prices and a bigger drain on the economy, which is already feeling the effects of the huge debts through all kinds of surreptitious taxation on everything from road tolls, to bottle deposits. In the end it seems very unlikely that any rate increase will be tolerable, or possible no matter how the economy reacts. This is why acquiring supersized global debt loads as a matter of economic stratagem was never thought to be of any real value in the long run. The debt itself would eventually work to restrict the possibility of any sustained economic growth.
Deflation and Loss of Control
However, that’s only half the story. The other half, perhaps the more dangerous half of the Fed story is this: what if things start to happen that the Federal Reserve can no longer address? That possibility is not only the most dangerous, but most likely.
We have previously posed the possibility that the Federal Reserve of the United States may soon become dysfunctional because it has undermined its own foundations. The Fed is supposed to control economic velocity, that is its prime function and in essence should really be its only function. If any other function were given to it, it should have had to do with directing economic velocity towards particular sectors. But that would be the limit. Today the Fed has been charged with increasing employment, something which should be far beyond its grasp, since that can only be done by the Free Market once established, or else by the Federal Government directly through hiring or public contracting. The Federal Reserve should never have been allowed to play with the nation’s money supply in order to manage both employment and rate of interest. Moreover, the Federal Reserve should have been tightly controlled by the American people, and yearly audited as some Senators are now demanding in order to make certain that money supply was very tightly regulated. At this point, it seems clear that the Federal Reserve has taken all kinds of unheard of liberties and dispensations which have put it at severe risk of failure as it is now a primary organ of the economy.
This is indeed what we may seeing now, essentially a “broken” central bank deeply indebted and unable to free itself from that debt. For at least twelve years the Federal Reserve of the United States has embraced a very liberal monetary policy. Even under Greenspan, who at times tried to restrain the “enthusiasm” the Fed was pretty much committed to total expansion with little reservation. The idea was that one day, after a few years of loose monetary policy, the economy would become so “hot” and attain such high velocity that it would then be necessary to pull it in by increasing rates and normalizing. But this hasn’t happened.
What has happened instead is that the global economy collapsed completely in 2008, and the various governments around the world sold their souls and bailed out the banks that had borrowed gigantic sums of money and lent it out to less than prosperous ventures.
After the collapse of 2008, we were all told that we needed more loose monetary policy in order to resurrect the economy from the “great recession” and that one day soon the economy would become so hot and fast that there would be no problem in raising rates and normalizing interest rates. But that has not happened. Not only that, it doesn’t appear to be happening any time soon.
As some have pointed out, inflating the Global Economy with all this money is going to create a negative growth potential(deflationary potential) that will only increase in magnitude the longer interest rates are kept at zero interest. Others have insisted that we should keep rates at zero interest forever failing to see the obviously deleterious long term effects. Now we are seeing a global currency war fully maturing as just about everyone on earth is giving money away freely in order to keep their economies from collapsing altogether. Unfortunately in a Global Economy any significant collapse of a large individual economy could easily initiate the collapse of the entire structure. Some places actually punish anyone who even attempts to save. The net result however has not been good, and it really does not seem to be getting better. Despite all the central banks are doing, the deflationary forces have not dissipated, and are only getting stronger.
Liberal Rate Policy, Deflation Persists
The price drop of oil shows some serious flaws with the loose monetary policy adopted by Fed for so long, and it is a flaw that pervades the entire Global Economy. Simply put, overproduction is the chief cause of deflationary forces. We are producing more than we can process. And the more we produce the more depressed prices get. This makes it impossible for the Federal Reserve of the United States or any other nation to raise rates any time soon since that would indeed cut production oversupply, but also employment and money velocity and flow. Unfortunately this dilemma also condemns the present economic philosophy of a liberal monetary policy being conducive to long term growth. The Federal Bank is now compromised. It has lost its way and cannot maintain control of the economy. Either way, it will see failure.
Should the Federal Reserve force interest rates higher, there will probably be a gigantic stock market loss. The market has so far stood on the cheap price of money and has completely ignored the actual state of the economy. Tomorrow, should rates rise, it is likely that once again little in the economy will keep stocks buoyant and prices will begin to drop in earnest. Losses could be significant should it turn out to be the case that the only thing the market really counted on was cheap money.
In the end the present strategy seems to have failed and the failure is universal. We don’t see the raging economy we should have seen for all the cheap money, instead what we see is a few people having reaped all the benefits of monetary policy while the majority are left to pay for the bills. We should not think that a jump in prices now is going to do any good, it will not. A jump in prices now will only further the instability of the general economy, and the consequences will be a reaffirmation of the downward trend. Should prices rise, the market rate will probably expand far beyond what the Federal Reserve would consider comfortable, but there would be little it could do. The instability would begin in earnest.
For these reasons it seems unlikely that anything good would come from a rise in rates right now. Perhaps, if the economy around the world could stabilize long enough there might be a chance of a highly coordinated global tightening, but that’s really not all that likely any time soon given the rising instability we are seeing. Rather, each nation will have to slowly come to the realization that the game is coming to an end, and begin to take measures to reign in what has not really been all that great an idea i.e. the liberal monetary philosophy that we have seen dominate the world’s economy for the past fifteen years.
So will she or wont she? She probably wont-at least not any time soon barring a highly unexpected turn of events.