When Will the Fed Raise Interest Rates?

This is the question asked by many traders who want to tie the purported beginning of the bull market to some real fundamental improvement in the economy.

As the economy moves out of the slump, it is argued, the Fed will be forced to admit that it cannot keep rates at where they are for long without kindling the risk of rampant inflation.

And as many propose that we’re witnessing the end of the recession, it is only a matter of time that the Federal Reserve realigns itself with the changing facts and acts in accordance.

In fact, traders in Fed Funds Futures are giving a better than even chance that Mr. Bernanke will raise rates above the abysmal 0.25 percent by January.

How likely is that? Our position is that this economy is being sustained by easy money and speculation and nothing else. Certainly, the unwillingness of the Federal Reserve to raise rates even a tiny level above the 0-0.25 band, in spite of the recent impressive rally in almost all markets is a clear sign that they concur to this analysis.

Let us remember that monetary easing has been going on since September 2007. We’re close to August 2009, and there is very little sign that the Central Bank’s easing of credit has translated to any pick-up in investment activity, or consumer spending. Monetary policy is having little effect because the economy has reached a “money saturation” point in the last two years.

Contrary to the theories of Friedman, and his colleagues at the Federal Reserve, unlimited supply of money does not always lead people to do something (invest, employ, consume etc.). Sometimes it just causes asset appreciation which fails to generate confidence because people are aware that behind the facade of wealth generation at the financial markets, there is just a little bit of “nothing” going on in the real world of real economic activity.

Mr. Bernanke himself is at an important crossroads in his career. But a different version of the same small-scale doom is awaiting the U.S. economy regardless of the path he takes, and he is sure to acquire a unique place in the annals of the Federal Reserve, right aside Mr. Arthur F. Burns who presided over the institution in the 70’s, no matter what he does.

If he succeeds in preventing the economic misery that is threatening to overtake the American economy, if he can help the U.S. avoid a depression, he will have done so at the cost of an incredible, unimagined debt burden that must still be paid somehow with shrinking tax revenues and increasing commitments.

Ironically, if American policies help the Chinese to transform their economy into one that is less based on exports, one of the major purchasers of Treasury bonds will have less cash and incentive to bail-out the American government.

Eventually, a collapsing dollar, and economic turmoil will be the outcome. If he fails, and a depression takes hold, it is unlikely that the external position of the government will be that big a problem, but the cost in unemployment, despair, and economic inertia will be just as severe.

The result will still be turmoil and mayhem, but in a different form.

Our position has always been that the behavior of the Federal Reserve and government is mostly irrelevant at this stage of the crisis. They can turn a chimera into a dragon, a sphinx to a Cyclops, but eventually, no amount of financial and economic wizardry will suffice to somehow sweep away the problems of the global economy, or to turn back the clock.

Only the natural course of events, the sufferings that must be born, the chaos that must be experienced, will create the conditions for the eventual rebirth, but that is a long way away from here, for now.

Comments

[cameroni:]

Easy money that nobody wants and even fewer can access?

Easy money of course is cheap money that is readily accessible. I don't know that our current situation is an "easy money" economy despite policy built around that agenda.

But with savings up sharply and lending being tightened for all but the best credit-risks we are not yet living the life that all that cheap money might suggest. At least, not yet.

Interest rates will rise when our credit rating falters, when bond sales don't attract buyers, when lending risks exceed rewards and when real inflationary pressures are exerted on our daily lives.

On July 21st 2009 Forex Traders wrote:

"Our position is that this economy is being sustained by easy money and speculation and nothing else".

Jul 21 03:53 AM

[mcnoodles:]

While inflation v deflation debated has raged and the short term signs have would suggest that at least 'massive inflation' will not materialise any time soon, it seems as if it can only be so long before the floodgates burst from the amount of money being pumped into the system. While there are many reasons banks have tightened up their lending; Is it possible that the banks concur with this inevitability and simply don't want to lend all this money as they themselves anticipate future inflation? Why lend any of this money that will be paid back with cheap worthless dollars several years down the line? It would occur to me that the bankers and powers that be should at the very least be one step ahead of us.

Perhaps fillings ones boots with cheap fixed rate cash if they can get it and buying assets might not be such a bad move. If these assets are mortgaged then surely the value is irrelevant, it would be the price that mattered..

Jul 21 04:34 AM

[Moon Kil Woong:]

The Fed will always keep rates too low for too long. They will also always raise rates only when that have too. This time it's no different save the fact they hit a new bottom in keeping rates low (Greenspan still has the record for keeping rates too low for too long). Since Bernake is a follower of Greenspan (He was elected on that premise) until he found out Greenspan was unpopular I suspect he will try beating Greenspan for his record of too low of rates for too long.

That is why I hope Obama sacks him before that happens. Unfortunately, Larry Summers may not be any better than Bernake. Certainly Geithner is just about as untrustworthy Paulson if not more (Paulson is just blatently greedy). Republican or Democrat, the Federal Reserve and USA Treasury remains as self absorbed and unvigilant as ever against fraud abuse and dollar depreciation.

Jul 21 04:55 AM

[derryl:]

Forex Traders wrote, "Only the natural course of events, the sufferings that must be born, the chaos that must be experienced, will create the conditions for the eventual rebirth, but that is a long way away from here, for now."

The "natural course of events" involves personal and business financial failure, default on unpayable loans, bankruptcy, and a consequent writedown of the debts by banks, and possible bankruptcy of the banks with further debt writedowns as bank assets are bought by other banks at firesale prices. If you're close to the source of money--the Fed--then you always have money to buy firesale assets. Ownership of the nation's assets gets more concentrated. That's the "normal" way to deal with a debt crisis.

Notice that it always involves writedowns of debts. Each time assets are foreclosed and sold at a lower price, more debt gets written off.

The current problem is excessive debt beyond the capacity of the economy to service and beyond the psychological capacity of the people to bear. If everyone tries to service and pay down their debts we get a deflationary spiral with collapsing consumption then business contraction and failure and layoffs and collapsing incomes and, consequently, even more inability to pay debts. If the government tries to pay off its debts then it has to tax more and spend less and give all the savings to its creditors, which starves taxpayers and government spending recipients of incomes, which causes a deflationary spiral.

The ONLY way out of a situation like we're in involves large scale writedown of debts. The market approach to this scale of writedown is called a "depression", let the chips fall where they may. Last time we had one of these the free market could not get up again. Prices kept going down because nobody had money to pay prices. It took a world war with massive government borrowing and spending to get the beast started up again.

War spending is an "intervention" in the market, by the way. The market approach to a debt crisis means the permanent collapse of that market economy, a terminal deflationary spiral from which no recovery is possible because too few people own too much of the economy and you get a general collapse of "effective demand", which is the desire to buy stuff backed up by having money to buy stuff.

The government paid incomes to millions of people for their contributions to the war effort, building weapons, fighting, etc. All of the products built for the war effort were blown up. In other words, the government released all that money into the economy as earned incomes (i.e. the people got the money as incomes, not as loans/debt) which the income earners then spent reinflating the economy. Prices rose because people had money to pay prices.

They got the money for helping to build things that were meant to be blown up. In other words, they were paid for digging holes then filling them in. Their "production" was not to be bought by them and consumed. It was to be destroyed as soon as it was built. Consumption was rationed so savings grew.

What did remain was the capital plant that was built up for war production. The companies who benefited from this became the big corporations that arose after WWII. These were the American employers who provided so many of the good manufacturing and R&D jobs in the postwar prosperity. The Marshall Plan and other US initiatives succeeded in rebuilding Japanese and European economies to serve as export markets, but this could only be temporary because the importers would soon finish rebuilding and become competitors.

Once American industry started feeling the competition those "good US jobs" started to look like 'expensive US labor', so offshoring and outsourcing happened. The middle class changed from production workers to service workers, in banking, teaching, policing, etc. But without the primary (resources) and secondary (manufacturing) foundations, the tertiary (services) industry had no real, physical underpinning. It was a virtual economy.

For a couple decades this Wile E Coyote off-the-cliff economy was supported in midair by increasing private and public debt. But last September Wile E looked down, saw there was nothing supporting him but thin air, and fell.

So there are two big problems here. The first is debt. More specifically, it is debt that is owed to privately owned fractional reserve banks who create money out of nothing and lend it out as 'debt', at interest. Running an economy on this monetary system can have only one outcome: debt crisis. It happens over and over. Bankruptcies, firesales, debt writedowns, and increased concentration of ownership. This is fractional reserve capitalism.

"Whose" money did the banks lend? Not their own--they created it out of nothing. Not their depositors'. It is illegal for depository institutions to lend out their depositors' account balances (unless the depositor 'invests' in a GIC or similar vehicle). Not the Fed's. The banks didn't give you $300k in Federal Reserve Notes to buy a house. They made an electronic deposit in your account and you wrote a check against it. So "whose" money are the banks lending out?

This is important, because whoever put their money at risk deserves to get the assets if the borrower defaults. Ultimately the money belongs to the US economy. By offering that money, anyone can get that economy to work for him. "Here's $300k. Build me a house." "Here's a buck and a half. Make me a hamburger." The only ultimate value of the money is what the economy will give you for it. It is the economy's money, which it uses to facilitate trade in goods and services.

So why does the bank get to own the foreclosed asset? And why does a bank like Goldman Sachs, who was just as insolvent as the other bubble players, get direct access to Fed money creation and US Treasury/taxpayer money so GS can buy up firesale assets and GS employees can get million dollar bonuses and GS can end up owning the whole country? The money and the assets it was loaned on are the property of the economy, the citizens and taxpayers, not a bank or the banking system or the Fed.

This is why the constitution gives the federal government the authority and responsibility to provide money for the nation's economy. Under the Federal Reserve Act, US money is the private property of the Fed. Still wondering why there are ongoing debt crises? The only way to get your own money is to "borrow" it, at interest. The only way for the government to get its own money is to borrow it at interest. Good deal for the banksters.

Debt is going to be written down, one way or another. The "market" way leads to deflationary collapse. The "interventionist" way can lead to war, or some more productive use of the economy's idle capacity. The real question is, who is going to get the benefit of the debt writeoffs? The economy? Or the banksters?

The second problem is the undermining of the US economy by global corporations. During the postwar period a lot of former colonies gained independence and immediately became economic basket cases. Why? Because the colonial economy was set up as a cog in an empire's wheel. A whole country produced nothing but sugar cane and had to import everything else from its colonial master. Once the preferential trade deal was dissolved there was no built in market for the cane and the people could not earn income to import their necessities of life.

The US is a far cry from a post-colonial basket case, of course. But it's a mistake to be too import dependent. Again, a few people at the top of the food chain benefit enormously from this arrangement, but the middle class loses its reason to exist. It is true that free trade makes consumer goods cheaper. But if everybody's broke because they have no job producing consumer goods, what the hell is the point?

Jul 21 05:13 AM

[Dirk McCoy:]

Dr. Taylor (of Taylor Rule fame) did some work showing that during the recovery after 2001, the Fed was a couple quarters late in raising interest rates, and then overshot the target.

Bank short term rates are so far above Fed overnight rates that a 1% increase won't raise real lending rates, but will slow down bank profits. And bank profitability is required to rebuild bank confidence to make slightly riskier loans (for example, to startup companies).

Meanwhile, a black market in labor is developing to get around minimum wage and company wage scale price controls, so the prospects for labor-driven cost-push inflation are still very small.

Thus, I don't see the Fed raising rates until bank balance sheets are very healthy and banks resume lending to startup companies- even if gasoline hits $4- which it could, given OPEC oligopoly, North Sea manipulation, US refiner regulation, and weather shocks.

With milk commanding its lowest price relative to wages in history, it's kind of funny- or ignorant- that someone would complain about inflation in that commodity.

Jul 21 10:22 AM

[EUARTE:]

The column has a very theological sound. Only through suffering can we better our economy. Putting off the suffering only increases it. Hopefully we will only suffer Purgatory although some will rightfully suffer hell.

Jul 21 11:50 AM