Quit calling for the Fed to raise interest rates already!
It seems like only yesterday that we were all assured that as soon as QE3 (third round of quantitative easing) ended then we would immediately crash into a double-dip Great Recession… the second iteration being worse than the first.
But nonetheless the Fed announced in Dec 2013 that they would taper QE3 by $10 billion/month, and from January 2014 to October 2014 the program tapered and was eliminated… and the U.S. saw a GDP growth of 2.4%, we added 2.8 million private sector jobs, and we gained 3.06 million private sector jobs…
So it might come off a little hollow when I say that rushing the Fed to raise interest rates could seriously harm the economy.
But seriously… Rushing the Fed to raise interest rates right now could crush our recovery!
In the 2nd quarter of 2013, my voice was one small voice in the clarion call for the Fed to begin tapering QE3. (I am not – on the whole – a fan of Fed-based stimulus. I prefer honest stimulus like infrastructure, renewable energy and energy efficiency upgrades, and serious R&D appropriations.)
But I became quite concerned late in the 2nd quarter of 2014, and in August 2014 I started saying we might need to slow down the taper. By November – after the taper had run its course – I started to speculate that we might need to implement a small QE4. Now, I’m nothing short of horrified by the calls for raising rates as soon as possible, as I’m certain that doing so now would risk sending our economy into a recession.
So, am I Chicken Little or Cassandra?
Perhaps the better question is: between late 2013 and the summer of 2014; what changed?
The answer –Putin’s Folly. Russia invaded the Crimea and started a small-scale skirmish war in Eastern Ukraine.
For those that haven’t been drowning in meaningless hype for the past year, your immediate response should be “so what”? After all, the Crimean Penninsula has a population of ~2.4 million people. The main industries are farming to service their impoverished nutrition needs and tourism to service Eastern European nations. They were invaded by a has-been of a country who we only have a total of ~$30 billion/year in gross trade with during the best of times.
In terms of direct impact to our economy, it literally matters more which city is selected for the Super Bowl.
So what do I see that scares me in all this?
Please follow the links to more information about these threats if you are not feeling appropriately frightened.
Putin’s Folly caused a dramatic slowdown in the economies of Europe, and a collapse of the Russian economy (at the time Russia was the 7th largest economy in the world). This lead to a slight deceleration in the U.S., China, Japan, Turkey, Middle Asia, India, Southeast Asia, Northern Africa, Canada, and Central and South America – who all had significant trade with either Europe or Russia.
The combined effects of the collapse of Russia, the slowdown in Europe, and the slight deceleration in the rest of the world economies through lessened trade with Europe and Russia; had a major impact in the price of oil. Multiple economies (including Russia) that were heavily dependent on oil – and which had benefitted from a large influx of foreign investment – suddenly seemed like terrible investments. Investment had already been hemorrhaging from Russia, and Europe had once again begun looking like a pretty poor place to keep funds… but by this point China was undergoing reforms, Africa’s oil was not worth the hassle, Venesuela was certainly not worth the hassle… Japan remained forever stalled, etc.
Through it all, America became the bright city on a hill. Our markets were in the middle of a 6 year bull run, our businesses were seeing extraordinary profit, our real estate markets were coming back, our national deficit was reducing faster than any country has seen in 60 years… etc…
America suddenly became the place to put your money. This was true for both American investors and the investors in every other nation… and so even with near 0% interest our banks were getting more money invested into them than they could loan out under the tighter lending standards. Even with an initial 10-year treasury yield of >2.8%, the 10-year bond rate has dropped 0.8% since tapering began.
The dollar began strengthening VERY rapidly against all currencies as investment wealth fled other currency and concentrated in the USD. While a strong dollar has its benefits, a rapidly strengthening dollar has its drawbacks, and the threat of core deflation continues to loom ever more eminent.
Chart showing the month-over-month (MOM) and year-over-year (YOY) increases in consumer price inflation for all goods and services (CPI) and core CPI – the consumer price inflation of all goods and services less energy and food. The chart may require a little more explanation: Currencies of the top 25 economies in the world as of the beginning of 2014, as well as gold, silver, and platinum for the sake of those who believe the metals have some mystical economic properties. I then charted their relative conversion rates compared to the conversion rates on Jan 1, 2014. So – if you track the Argentine Peso, you see that it dropped by nearly 20% from Jan 1 2014 to Feb 1 2014. On Jan 1, 2014, it was trading at 6.52 pesos/dollar, and on Feb 1, 2014 it was trading at 8.02 pesos/dollar. It’s value had dropped by 18.7% relative to its prior conversion rate against the dollar, so the trace on the graph above dropped from 100% to 81.3%. You can see that by March 2015 every single currency has dropped significantly against the dollar over the past 8 months, all save for Saudi Arabia (which is fixed to the dollar). Also dropping against the dollar are the precious metals, just because I’m sure someone will wish to claim that we are “only dropping less than other fiat currencies”. The countries using these currencies made up 63.2% of the total global GDP before Putin’s Folly, and the U.S. constituted an additional 19.2%. The remaining currencies have similar effects, but are individually too small to map out.
And this is where we find ourselves today. Right now, the strong dollar is clearly impacting our ability to trade and compete. This is somewhat masked by the gain we’ve made in our trade deficit from reduced oil prices, but that balance will not last long. Further strengthening of the USD – especially rapid strengthening will certainly result in tipping the scales against us (it’s not as if we can expect the price of oil to drop another $60/bbl).
But far more significantly, we are teetering on the edge of deflation, and raising interest rates exerts deflationary pressure on the currency. This is always so.
Raised interest rates reduces consumption (people slow down on purchases since the cost of credit is higher, and people are more inclined to pay down debt), thereby reducing the gains in the stock market; while simultaneously increasing gains from CD’s and savings deposits. More money is dumped into the bank while less is loaned out. This is “deleveraging”, meaning less money in circulation is borrowed from future productivity, giving the money in circulation more real-world value compared to existing goods and productivity, because there’s now less money in circulation that has been borrowed against the future; while the quantity of goods and services remain the same.
So what possible justification could there be to scream that the Fed needs to raise rates while CPI is negative and core CPI is at the low end of the target range? What purpose could it possibly serve?
Do you feel the function of the Fed is to level the playing field? Since people who sought the safety of the mattress missed out on the 6 year bull run, is the Fed supposed to then risk the economy just to help them out… or perhaps crash the broad market to give them new buying opportunities?
The media has been screaming for higher interest rates for half a year now. Why? We should be examining more stimulus measures. The only reason to avoid stimulus is because of fear of inflation, but we WANT inflation, to push us away from the far greater threat of DE-flation.
Well, that’s this week’s rant. I look forward to discussing this more (please remember the concept of civility) in the comment’s section.
The good news – for those of you that somehow feel that you’re entitled to a rate increase because the Fed should balance the winners and losers… We will see rate hikes by the end of the year. The overheated jobs market is tightening fast, and that will force wage hikes, which will help push inflation. It won’t be one-to-one, but as wages start growing more quickly we will start drifting away from the cliff of core deflation, and we’ll probably need to start ramping up interest fairly quickly to head us off from the path to runaway inflation.
I’ll discuss the labor market with my next economics post… which won’t be my next post but will be coming soon. Please check in often for updates, discussion, and errata.
Thanks for joining us.