Time For The Fed To Stop Fixing Interest Rates

by: Paul Nathan

Summary

It's time for the Fed to stop guessing at what the fed funds rate should be and let the markets determine the real rate of interest.

There is no difference between the doves and the hawks -- both want to impose their opinion of where interest rates should be on the market. Both are artificial.

All the gyrations of the stock, bond, commodity, and currency markets would end with the Fed exiting the market.

Question: "Why must the world hold its breath every time the Fed meets?"

My answer is that they shouldn't. It's time for the Fed to get out of the rate fixing business. It's becoming clear to almost everyone that the Fed, indeed central bank policy in general world-wide, is either impotent or counter-productive.

Now, I acknowledge that the Fed is doing a decent job especially compared with the Feds of the 20s, 60s, and 70s. But their effectiveness may be coming to an end.

There has been an ongoing battle between monetary doves and monetary hawks as to when to raise interest rates. The battle has been within the Fed, as well as outside the Fed in the real world of economists, businessmen, and investors. Everyone is preoccupied with the Fed.

The thrust of the hawks' argument for the Fed to raise interest rates is the necessity to "return to normalcy". They argue that interest rates have been kept artificially low by the Fed for eight years now.

Question: why do they think rates are artificial? The Fed is out of the market. There is no longer any bond buying. The money supply is low and stagnant as is the velocity of money. The Fed's open market activities have recently been neutral for some time.

And why do they think long rates are artificially low when the Fed has no control over long rates? Long rates are controlled by a world-wide market -- not the Fed.

Further, how do they explain the historically low rates world-wide despite the variance of monetary and economic policies at play by a host of different governments and central banks? Some monetary policies are extremely loose and others relatively tight. Yet, all interest rates are historically below normal.

I would argue that the abnormally low rates (short and long) are indeed abnormal and historically low, but they are not controlled. They are near market rates regardless of, and in spite of, central bank policies. Market rates long and short have been falling for decades.

The last Fed rate hike in December when the Fed raised the fed funds rate is instructive: long rates continued to fall regardless of the Fed increasing the fed funds rate and short rates here and around the world followed. It was as if the Fed had done nothing except rattle the markets.

Governments cannot control long term interest rates; markets are in control - not governments and central banks.

If you accept this view, why continue the charade of central bank intervention? And why assume the Fed can return interest rates to "normal" by raising them? The monetary hawks are actually arguing for an artificial rate increase. They are arguing to impose their opinion of what's "normal" on the market. And so are the doves. Both are jumping outside the markets and telling us why they are right and the market is wrong.

So I ask: what's the difference between the doves imposing their view of where interest rates should be and the hawks imposing theirs? They are both artificial.

I on the other hand argue that the Fed should stop pegging the fed funds rate. They should get out of the price fixing business and leave all interest rates to the markets -- free of government intervention.

My guess is that interest rates wouldn't be much different than they are now if the Fed did in fact vacate the market mainly because the Fed has been following the market for the most part in their decision making. And they have not been intervening in markets as they were under QE.

If the Fed exited the market we would actually know the real rate of interest. It would be the market rate; and we would be done with all the Fed drama, which in my view is totally unnecessary.

Why have a Fed in charge of guessing what the right interest rate should be when the market will tell us instantly? The only mandates the Fed should be charged with are fostering price stability and serving as a bank of last resort.

All of the anxiety leading up to every Fed meeting can be dispensed with if the Fed got out of the interest rate business. All the stock market gyrations, the commodity swings, the currency shocks, and the bond market turmoil due to the Fed's interest rate decision would simply disappear. The same would be true if other central banks around the world would do the same.

The upcoming June decision is typical. Investors are forced to become speculators as they buy and sell defensive or aggressive positions. Many now hedge their positions with defensive derivatives, all unneeded except for the Fed's decision-making authority over interest rates. And if the consensus is wrong and the market is surprised by the decision, days of turmoil in the world markets will result. It is all unnecessary.

To add to this chaos and confusion, we have the specter of varying central bank policies ranging from negative interest rates, which hardly anyone knows the consequences of, and loose and tight monetary policies that conflict with one another from one nation to the next. All of this leads to currency volatility while investors make or lose money, not on the validity of their investments but from playing the volatility of bonds, stocks, commodities, and currency values.

I agree we need to return to normalization, but normalization means returning to a free market economy in fiscal matters as well as monetary matters. Free markets lead to normalcy; government controlled markets lead to just the opposite.

It's time to begin questioning this government imposed, time-tested, failed policy.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.