Why The Fed Likely Won't Raise Interest Rates Now - But Why It SHOULD

The news this morning in The Financial Times that the World Bank has warned the U.S. Federal Reserve not to raise interest rates at its September meeting, is depressing to say the least. The reason given is that such a raise (only 25 basis points, or 0.25%) would "create turmoil in global markets" especially after the Chinese devalued their Yuan, and hence would bring "chaos" to emerging markets.

Of course, this is rubbish, merely more flatulence to support the speculators who are high on equities' crack, and the Fed's quantitative easing (QE).  Whether the Chinese manipulated their currency to gain an advantage (cheaper Chinese goods) is their business, and they have to live with the fallout - or benefits such as they are. But for the U.S. to hold back any rate increase because of fear of roiling emerging markets is bloody bollocks. (Especially as the FT later reported the emerging markets were calling for a Fed rate increase!)

It isn't very often I agree with conservative economics guru Martin Feldstein, but I do now (cf. 'The Fed's Stock-Price Correction', Aug. 25, p. A11)  as when he writes:

"Market participants know that the economy is now essentially at full employment, that the consumer price index is close to 2 percent and that there is little risk of deflation. They know therefore that interest rates must rise, and that a return to normal levels will reverse the mispricing of assets. The Fed cannot hide that realization by postponing rate hikes for a few more months. And so the Fed should get on with the task of normalizing rates, particularly so investors and lenders are no longer tempted to sink deeper into mispriced assets."

There is a lot here to unpack, so let's begin by examining the claim of "mispriced assets" which to me represents (as it does to Feldstein) the central core of why rates must go up.

Right now those in the stock market, especially in equities, are riding a huge asset bubble. The bubble has two components that are perilous but which too few - high on the nose candy of their share prices - ignore. One is the very excess price of equities, or more exactly, the high price to earnings (P/E) ratio of most of them. The rapid rise has already foreshadowed one shot over the bow - the recent 12 percent correction (-1200 pt. plunge) in the DOW, that ought to have signaled to any sentient person he was holding mispriced assets. But after the initial plunge, the DOW bounced right back up and every maniacs has since forgotten about it.

As Feldstein also noted (ibid.) while these same investors may have realized the rapid increase in share prices was a bubble waiting to pop - they still invested on the mistaken belief they would know when to pull out, But in more than 90 percent of cases ordinary investors really have no clue when to pull out. Their emotions generally lead them astray.

Market timing has never been developed into a high art, and only a fool would believe he or she can practice it reliably.

The other worrisome aspect is that other mispriced assets, including real estate are afloat, As Feldstein notes (ibid.):

"As investors reached for yield in a very low yield environment the spreads between Treasury rates they depressed the yields on high risk bonds and emerging market debt. The prices of commercial real estate have also been pushed to extremely high levels, driving down yields to unsustainably low levels."

Most worrisome:

"Banks and other lenders have boosted their short term earnings by lending to lower quality buyers and making loans with fewer conditions."

Echoes of the 2008 financial meltdown, anyone? Recall the credit crisis was hatched by sub-prime lending gone wild. Even Feldstein is worried as he frets that there may well be "adverse systemic effects" such as transpired in 2007-08.

Let us hope not! But understand this: the introduction of a Fed rate increase is a badly needed dose of medicine right now, to temper the mispricing that's characterized this boom cycle. And the longer the Fed delays administering the medicine, the worse will be the reaction when it finally is given.

As Feldstein puts it (ibid.):

"It's time to escape the unprecedented monetary policy that for a while stimulated demand - but then distorted prices and brought about the current corrections."

Lastly, if the Fed refuses to raise rates at this month's meeting, and the economy really does come a cropper, it will have no wiggle room at all. None, nada. Unless they want to go into negative interest rate territory!

Lower Living Standards For Generations To Come? Thank Global Monetary Policy

In many areas of the corporate Pollyannish press one reads about the expanding future and how many millions of more gadgets and processes will make our lives easier. Oh, and it'll all be much cheaper and we'll each even have our own drones and driverless vehicles.  To read some of this codswallop one would think a limitless cornucopia is soon upon us and everyone will basically be on "Easy street". Don't believe it for a second.

As the Mar. 25  Financial Times article ('QE Will Lower Living Standards Long Term')  puts it:

"The prospect of improvement in economic growth is largely a monetary illusion. ....Lacking the political will necessary to address the issues, central bankers have been left to paper over the global malaise with reams of fiat currency"

By "paper over" the FT means the ongoing practice of QE or quantitative easing  - which has already resulted in the Federal Reserve infusing more than $4 trillion into the U.S. bond markets and - combined with essentially zero interest rates - fed a ginormous stock market bubble.

Accentuating this low note, a report by the Bank of America -Merrill Lynch has projected that the year 2015 will mark the first decline in growth since 2009 the year after the financial meltdown and credit crisis. The FT piece notes how the Fed's QE, for example, has "perversely morphed into a new monetary orthodoxy" where central bankers themselves use their balance sheets as tools to implement fiscal policy.

This as opposed to politicians doing it via new regulations, tax reforms, monetary policy. But see - the politicos these days have no courage. They are all basically spineless worms who so fear the T-word they are afraid to actually practice representation. Thus, as the FT notes:

"The politicians lack the willingness or ability to implement labor and tax reforms."

So, because of these venal jackals, the banksters (in which I include central banksters)  are de facto allowed to set policy with their QE. But long term it isn't working and the world will become poorer for it, that is - the world our children will inherit.

Much of this follows from the extent to which QE policies damage fiscal health. For example, the FT points out correctly the negative impact of QE on interest rates. The depressed returns available on fixed income securities (such as commercial paper), largely as a result of QE, effectively act as a tax on investors, including individual investors.  At the same time the QE is providing a subsidy to borrowers.

If you have your money stashed in a money market fund for commercial paper - which is used to fund new  business investment - there is little reward given the 0.5 percent rates, so there is a bigger incentive to pull the money out and put it elsewhere for higher yield (say in an online bank for a fixed income account for which the interest is doubled.)  Practiced widely such pullouts will  dampen investment and stifle new business. As the FT puts it:

"The cost of QE is greater than the income lost to savers and investors. The long term consequence is likely to permanently impair living standards  for generations while creating a false illusion of reviving prosperity."


Less on the radar but surely playing a role in declining living standards is the ever degraded quality of energy sources. For example, current fracked oil (from shale) costs on average $70 a barrel to extract. If the oil price is less than this, that means the source isn't even at "breakeven" point in terms of energy returned on energy invested.. By contrast, the light sweet crude oil we'd been getting earlier returned nearly 18 times more than the cost to extract it per barrel. These are signs Peak Oil has come and gone (estimated in 2005) but most people don't even know what Peak Oil means. It doesn't mean the oil has stopped or slowed in production, it means the era of cheap oil is over,  making everything more expensive. Plainly put, our current energy -intense civilization is simply unsustainable in an era where only low EROEI oil is available.

You can read much more on this aspect here:

http://brane-space.blogspot.com/2013/09/44-trillion-in-deficits-by-2024-minus.html

$26 Trillion In Wealth Added - But Almost All To The One Percent

The article 'The Asset Rich, Income Poor Economy' (WSJ, June 20, p. A13) was a shock and wake up call for any ordinary citizen hoping the economy will favor them at some point. The evidence, instead, is that the richest have continued to make out like bandidos while the rest of us suck salt.

Let's again get our terms straight here: "asset rich" means bountiful in terms of stock or mutual fund ownership, including dividends and capital gains arising therefrom. It also includes real estate, for example owned and then flipped, or owned for later profit at re-sale.  "Income" means basically what it implies, any and all income - say from labor (where wages have stagnated since 1973) or from bank savings interest. Since the Fed has kept interest rates near zero, the latter group has had to not only suck salt but sand as well.  Thus, "income poor".

Meanwhile, the stock owners are doing well, thanks to the Fed - including under Janet Yellin now - continuing the misplaced quantitative easing program. According to the article cited above:

"The Fed assures us that long term rates need not move higher - even with improving inflation dynamics, credit markets priced for perfection and stock prices at record levels."

Indeed, the stock market (DOW, specifically) is in serious bubble territory and I personally would take every last cent out if I saw it hit or surpass 17,000. It is just a matter of time before that bubble pops  from some external shock (e.g. oil prices skyrocket over Iraq) even if the Fed keeps up its QE crack infusions. Meanwhile, as the authors (Kevin Warsh and Stanley Druckenmiller) observe:

"The aggregate wealth of U.S. households, including stocks and real estate holdings, just hit a new high of $81.8 trillion. That's more than $26 trillion in wealth added since 2009. No wonder most on Wall Street applaud the Fed's balance sheet recovery strategy. It's great news for those households and businesses with large asset holdings, risk tolerances and easy access to credit."

And that group is precisely the 1 percent, against which Occupy Wall Street so vigorously protested a mere three years before. It is this group that is benefiting from the Federal Reserve's QE crack infusions, and which also has the "risk tolerance" by virtue of having the disposable income to sustain sudden market dives (and losses) which most of us lack. They also have the easy access to credit and often hold real estate as well as stocks. In addition, they are often the beneficiaries of flash trading so can buy and sell before the hoi polloi can even pick up a phone. Hence, they will make more money on any redemptions, even as they will be able to pick up cheaper stocks before the ordinary bloke can say 'buy'.

As the authors note the current conditions "provide little solace for families and small businesses that must rely on their income statements to pay the bills."

They also point out that "about half of American households don't own any stocks" -  but I'd say the aggregate stats are even less asset -based. That is,  perhaps 75 percent of the half that DO own stocks (as mutual funds) don't have the disposable income to cover losses. We saw that play out back in 2008 with the crash incepted by the housing meltdown and credit crisis.

The bottom line is the Fed is not stimulating the real economy but the speculative one. It is playing a dangerous game of feeding a giant asset bubble via cheap money that will also hurt the real, Main St. economy if and when it bursts. (The Bank of England has already recognized the danger which is why they plan to raise interest rates.)

The authors are thus correct when they state: "Asset wealth is sustainable only when it comes from earned success, not fiat. Wealth comes from strong, sustainable growth that turns a proper mix of labor, capital and know how into productivity..."

The danger of feeding asset wealth to the exclusion of income is that the speculative economy then makes the whole economy unstable. A critical tipping point has already been identified by none other than stats guru Nate Silver.   In his book, his book, The Signal and the Noise- Why So Many Predictions Fail But Some Don’t , he writes (p. 347):

"Of the eight times in which the S&P 500 has increased at a rate much faster than its historical average over a 5-year period , five cases were followed by a severe and notorious crash, such as the Great Depression and the Black Monday crash of 1987”.

Already we are well into this treacherous territory.

George P. Brockway, author of  The End of Economic Man’‘ has written that any given Bull market's purpose is to suck the savings and nest eggs from the ordinary investor and transfer it into the hands of the richest speculators who know the small fry will never be able to resist rapidly rising share prices.  The longer the Fed feeds the stock market to the exclusion of helping income-based people the closer we come to yet another re-enactment of the collapsing Bull.