By Anthony Harrington
In an attempt to calm markets, which were crashing all around him, in mid-August Federal Chairman Ben Bernanke committed the Fed to not raising interest rates until 2013. “Don’t panic – cheap money will be available into the dim and distant future” is the message he clearly wanted markets to get. One can see why. Plentiful, cheap credit had fuelled the boom in the run up to 2007. Why shouldn’t it fuel another boom in 2011? Actually for lots of reasons, as we shall see…
In reality, the markets paid about as much attention to the Fed’s message as they did to the announcement by the French President and the German Chancellor that they would harmonise the French and German tax systems in five years. Excuse me? “Non/Nein” to Eurobonds, but “oui/ja” to a distant tax harmonisation? Sure, that will calm the markets, I don’t think.
Richard Fisher, President of the Dallas Federal Reserve was one of three dissenting votes on the decision by the FOMC (Federal Open Market Committee) to leave rates unaltered for so long. He gave an extremely cogent and forceful account of why he believed the decision to be wrong (hat tip to John Mauldin’s "Thoughts from the Frontline" for flagging up Fisher’s speech). For a start, he pointed out, there is no liquidity problem in corporate America, so trying to urge businesses to invest by guaranteeing cheap money fails to address the problem of why they are not investing:
“I have posited, both within the FOMC and publicly, for some time that there is abundant liquidity available to finance economic expansion and job creation in America. The banking system is awash with liquidity … Domestic banks are flush; they have on deposit at the Federal Reserve banks some $1.6 trillion in excess reserves earning a mere 25 basis points rather than earning significantly higher interest rates from making loans to operating businesses. These excess bank reserves are waiting on the sidelines to be lent to businesses … [At the same time] U.S. corporations are sitting on an abundance of cash – some estimate excess working capital on publicly-traded corporations’ books exceed $1 trillion – well above their working capital needs.”
In that environment, what impact can guaranteeing cheap money have? What concerns Fisher is that the Fed has failed to ask itself seriously why businesses are not making use of all the liquidity that is available. The reason they are not investing, he says, is quite simple. It has to do with political paralysis in Washington – the same paralysis that gave the world the tragic-comic cliff edge dance over the raising of the U.S. debt ceiling. That was a piece of political incompetence that led Standard & Poor’s to downgrade U.S. debt on the grounds that the U.S. political system couldn’t be trusted to manage its enormous debt properly.
The impact of political paralysis on business is enormous, Fisher argues:
“I have spoken to this many times in public. Those with the capacity to hire American workers – small businesses as well as large, publicly-traded or private – are immobilized. Not because they lack entrepreneurial zeal or do not wish to grow; not because they can’t access cheap and available credit. Rather, they simply cannot budge or manage [because of] the uncertaintly of fiscal and regulatory policy. In an environment where they are already uncertain of potential growth in demand for their goods and services, and have yet to see a significant pick-up in top-line revenue, there is palpable angst surrounding the cost of doing business. According to my business contacts, the opera buffa of the debt ceiling negotiations compounded this uncertainty, leaving business decision makers frozen in their tracks.”
Even with agreement reached on raising the debt ceiling, Fisher argues that nothing has been clarified, “except that there will be undefined changes in taxes, spending and subsidies and other fiscal incentives or disincentives”. All the Fed decision to anchor low rates till 2013 has done is to remove the only real incentive to action – the business person’s fear that if they don’t invest now, cheap money will vanish and rates will rise. They now know that they can, in Fisher’s words “plant their feet” and adopt a wait-and-see attitude, without worrying that rates will rise in the near future. Oops.
However, cheap money “forever” does have an impact – just not a good one, as the Fed mistakenly hopes. In his 'Thoughts from the Frontline' newsletter that I flagged up earlier, John Mauldin points out that by nailing down low rates, the Fed is “practically pushing people into higher-risk assets in a search for yield, at PRECISELY the time we may be slipping into recession, which will put those assets at their highest risk …”
Now that is what I call astute policy making. It is so reassuring to know that the U.S. economy is in capable hands …