The Fed got it wrong

The job market received a jolt last week when the Labor Department reported that just 38,000 jobs were added in May, the fewest for any month in more than five years. The experts expected a gain of 150,000 jobs and had included an estimated decrease of about 35,000 striking Verizon workers.

Equally disturbing, the job numbers for the two previous months were revised downward. In total, there were 59,000 fewer jobs in March and April than had previously been reported. This suggests the May numbers will be revised downward next month.

But it gets worse. Of the 38,000 new jobs, only 25,000 were in the private sector. Yet even as job growth stalled, the headline unemployment rate fell to 4.7 percent from 5 percent, in large part due to a drop in the labor force participation rate as many frustrated Americans stopped looking for jobs, meaning they are not counted in the unemployment rate. It’s an ominous sign that suggests the economy may be slowing.

Since the end of the recession, economic growth has been lackluster despite the Federal Reserve putting the pedal to the metal by pursuing zero interest rates and engaging in bond purchases known as quantitative easing. The rationale for this policy is that artificially suppressed interest rates and easy money are required for the Fed to fulfill its full-employment mandate. They assume that low rates stimulate business investment and make it easier for consumers to finance big-ticket purchases such as housing and automobiles.

The May employment numbers are just the latest evidence that it isn’t working. This should come as no surprise, since the Fed high priests’ failure to prophesize the 2008 crisis has been well documented.

President Truman once famously asked for a one-armed economist because his economic advisers kept telling him “on the one hand this, and on the other hand that.” For sure, there are pros and cons to the Fed’s monetary policy. Low interest rates have contributed to a partial recovery and growth may be stronger than it would otherwise have been. The rationale was to lower interest rates to encourage movement into riskier assets with higher yields, including stocks, junk bonds, real estate and commodities. The Fed has privileged Wall Street over Main Street in the belief that the wealth effect will trickle down to the ordinary American worker.

Lower rates would encourage greater leverage, i.e., borrowing to invest and boost asset prices. This pseudo “wealth effect” would then stimulate consumption, economic growth, and job creation. Such monetary policy raises the question of whether the Fed should be promoting risk and inflated asset prices that outpace real economic growth.

On the other hand, zero interest rates have created problems for savers, retirees and those on the other side of the velvet rope. Savers get virtually no return on their money market funds and saving accounts. Indeed, after inflation and taxes, real rates on these instruments are negative, promoting inequality and resulting in declining purchasing power. With so many Americans living paycheck to paycheck, is it any wonder that payday lenders are doing record business?

Lost interest is a permanent loss of wealth. Very low interest rates force retirees, who rely on interest income, to reduce their spending. Workers contemplating retirement will stay in the labor force longer to save more, blocking access for younger workers.

More importantly, low interest rates play havoc with retirement planning for both individuals and pension plans. Pension funds face increasing unfunded liabilities. Without adequate future income streams, retirement as Americans have known it is off the table.

Fed policy can’t overcome structural weakness in the job market that results from the twin challenges of globalization and rapid technological change. Continuing the policy of cheap credit is reminiscent of the old lesson about looking for a lost item under a lamppost at night because that’s where the light is. It’s time to look elsewhere for answers.

Originally Published: Jun 11, 2016

Negative interest rates are on the table

Just two months ago the Federal Reserve (the Fed) hiked the short-term interest rate it controls. The quarter-point increase was the first in nine years after efforts to pump up economic growth by keeping the rate close to zero. Now several members of the Fed are talking about reversing themselves and moving interest rates into negative territory.

It’s not such a far-fetched idea. Sweden, Denmark, Switzerland, Japan and the European Central Bank have introduced negative interest rates. It’s the latest toy in the world of monetary policy, where the economy is seen as an automobile and interest rates are the gas pedal.

When Fed Chair Janet Yellen delivered her semiannual testimony before Congress last week, she said the Fed has not fully researched the issue of charging banks to hold their excess reserves. But the plot took a sinister twist when it was disclosed that the Fed asked banks to consider the impact of negative interest rates during the latest round of bank stress tests.

Under a negative interest rate policy, banks are charged to park their cash with the central bank. The hope is that this will encourage banks to stop hoarding money and instead lend to consumers and businesses to accelerate economic growth.

No one knows if negative interest rates would work in the U.S.; the Fed has never tried them. Fully identifying their impact is very complicated, but we know how the story will play out for the average Joe. If the Fed charges banks for excess deposits, the banks will in turn charge customers for depositing money.

Still further, just because the interest rate is negative does not mean a bank will pay you interest (rather than the other way around) when you pay back a loan. The average customer will not get paid to take out a loan, not now, not ever, never.

Negative interest rates effectively charge the customer for deposits, discourage saving and encourage spending. Forget about saving for retirement and a child’s education; this policy is designed to grow the economy by coercing people to spend. Of course, the customer can at least be held harmless by holding cash and earning a zero percent nominal return.

The Fed has effectively punished the millions of American who rely on their savings to get by. Safe options such as savings accounts, certificates of deposit and treasury bonds offer pitiful returns forcing many people to dig into their principle to make ends meet. Under negative interest rates, the longer funds are on deposit the less money is available for withdrawal as banks charge to hold the money. Also, if people are unable to retire, many will either remain in or re-enter the labor force, thereby competing with younger workers for jobs or risk their savings by putting money in risky investments.

Crazy as it sounds, this may be the new normal. Remember that when the Fed thought they could not cut the interest rate any more, they engaged in quantitative easing: basically creating money out of thin air and releasing it into the economy, mainly by buying bank debt securities.

Bargain-basement interest rates and flooding the system with trillions of dollars in cheap money has produced sharp stock market gains -though even that has ended in recent months – and enabled corporations to buy back their own shares and pursue mergers and acquisitions instead of expanding production and creating jobs. It’s time for the public to ask what we have to show for these aggressive and addictive monetary policies that are a misallocation of resources and contribute to income inequality by shifting wealth to asset owners.

Monetary policy does not make for good presidential debate sound bites, but the time is long overdue for candidates to engage on the issue of federal monetary policy and how it has contributed to income inequality.

originally published: February 20, 2016

Fed’s ‘hard cheese’ for the average American

The Federal Reserve’s long-awaited September meeting ended with the Fed once again deciding not to raise interest rates. We have seen this movie before.

Consider a society in which government has been traditionally run by the Old Guys political party. They are great believers in “prudent government,” and their definition of prudence includes balanced budgets; having the government spend no more than it collects.

But along come the ambitious New Guys. They form their own political party with the goal of winning control of the government in the next election and begin campaigning aggressively on a platform that discredits the competence of the Old Guys.

“Look at our unpaved roads,” the New Guys thunder in their campaign speeches. “The people deserve paved roads so they can travel more safely and easily. But the incompetent Old Guys who run our government won’t give us the roads we need.”

To which the Old Guys calmly respond, “If the people really want paved roads, then the government should certainly provide them. But paving our roads will cost money, which would necessitate a tax increase.”

“Nonsense,” the New Guys shoot back. “Everybody knows the government is riddled with waste, fraud, and abuse. We’ll get rid of it all, which will free up more than enough money to pave our roads without raising taxes.”

Needless to say, the voters are drawn to the New Guys’ message of having the government pave the roads without making people pay more taxes. Getting something for nothing is very hard to resist in a society that lives beyond its means and wants political leaders who make certain the good times never end.

On Election Day, voters hand the government to the New Guys with a solid majority. But not long after they take over, the New Guys come face to face with two awkward realities.

First, there is not nearly as much waste, fraud, and abuse in government as they expected, and it doesn’t come close to adding up to the cost of paving the roads. In fact, the administrative cost of eliminating waste, fraud, and abuse is going to be more than the savings from doing so.

These all-too common realities put the New Guys in a real bind. The savings with which they planned to cover the cost of paving the roads turned out to be illusory.

They respond by punting on the use of fiscal policy to raise the funds necessary to pave the roads and deliver on their campaign promise before the next election.

Let’s get our “independent” central bank to pursue a policy of easy money and near-zero interest rates. That way, government will pay increasing portions of their ongoing expenses by simply “printing more money.” After all, the government has a monopoly on money as a commodity.

Equally important, Wall Street, which helps fund our campaigns, loves low rates and cheap money. Banks will pay almost no interest on savings, lending the savers’ money out to businesses, private equity funds, and hedge funds. Low rates also help companies that export goods.

Variations of this scenario have long played out in governments and it just happened again with the Federal Reserve’s decision not to raise interest rates. It’s a good deal for financial institutions that can play games with the cheap money they have been given without investing in the real economy.

As for the savers, including those who thought they had enough put aside for retirement, they will just have to learn to take more risks to achieve higher returns. As the Brits would say that’s “hard cheese” for the average American.

More evil has been carried out in the name of central banking than by any other force in human history, including religion.

Originally Published: September 26, 2015

Will Fed finally raise interest rates?

Investors are trying to figure out whether the Federal Reserve will increase interest rates for the first time in nine years at its Sept. 16-17 policy meetings. The guessing game is complicated by recent stock market volatility amid concerns about China’s economy, but it is unlikely the Fed would delay its rate hike solely because of the China effect.

The timing of the Fed’s decision to reverse its near-zero interest rate policy is further complicated by conflicting economic signals that emerged from the last major data point before the Fed meets to discuss a rate increase. The Labor Department reported that the U.S. economy created 173,000 new jobs in August, less than expected, but the headline unemployment rate dropped to 5.1 percent, the lowest since April2008 and a level the Fed considers to be full employment.

Weekly earnings increased to a 2.4 percent annual rate in August and average number of hours worked also rose; all good for increased consumer spending.

Wages and GDP from the second quarter that showed a 3.7 percent annualized growth rate may keep rate increase prospects alive. Moreover, a tightening labor market and decisions by several state and local governments to raise the minimum wage might give the Fed confidence that the inflation rate, which collapsed with oil prices, will move closer to their 2 percent target.

On the other hand, the broader measure of unemployment, including those stuck in part-time jobs and discouraged workers who have stopped looking for work, remains at 10.4 percent. The labor participation rate remains low at 62.6 percent.

And just to make things more complicated, the reported jobs and GDP numbers are far from certain. As always, you can expect revisions in the coming months.

In an effort to induce growth during the financial crisis and subsequent Great Recession, the Fed aggressively eased monetary policy in the final months of 2008, slashing short-term interest rates.

The Fed used additional tools to stimulate the economy by easing credit and keeping interest rates low. Making housing more affordable and enabling households to refinance their mortgages at lower interest rates would free up income for consumer spending. For corporations, reducing the cost of capital would promote investment. Commentators routinely argue whether QE has improved the real economy. Critics contend that reliance on ultra-low interest rates is insufficient to accelerate economic growth. The policies may support economic activity, but can’t take the place of fiscal policies such as addressing mounting debt, rising entitlement program costs, the need for infrastructure investment, repairing the tax code, and trade policies that advantage the American worker.

These critics argue that the Fed’s policies transfer wealth away from savers and force savers and pensioners to take on more credit risk in an effort to boost returns in an era of low rates. Corporations use cheap money to engage in stock buyback programs rather than capital investment.

Put another way, the Fed pushed trillions of dollars of new money into banks, but too little trickled down to the real economy and job creation. According to this crowd, the Fed has been fighting for the one percenters.

John Stuart Mill said, “He who only knows his side of the case knows little of that.” It will be very interesting to see what the Federal Reserve does when it meets later this month to sort out piles of conflicting data and decides whether it’s finally time to raise interest rates.

Originally Published: September 12, 2015

China’s power over US interest rates

While the Greek debt crisis and the Iran nuclear deal are all the buzz in the media, you may have noticed a major selloff on the Shanghai Stock Exchange over the last several weeks. There are global implications when the stock market of the world’s second largest economy is out of control, and the impact could be felt right here in the U.S.

China is a country of superlatives. Its population of more than 1.3 billion is larger than that of any other country. Its foreign reserves are about $4 trillion. The Chinese government owns $1.27 trillion in United States bonds.

As recently as the early 1990s, China was a minnow on the global trading stage, now it is the world’s largest exporter. It has helped lift hundreds of millions of citizens out of poverty and its per capita GDP has more than tripled since 1980.

Now that China has established itself as an economic powerhouse fueled by rapid growth, its foreign policy is becoming increasingly aggressive. It is asserting territorial claims over much ofthe South China Sea and their cyber-attacks on both business and government networks in the United States are creating a potential bipolar global rivalry with America just as the Cold War with the Soviet Union did.

China has evolved a system of state capitalism since the government began to introduce some market forces into the economy in the late 1970s. But the government is still the dominant economic actor despite all of President Xi Jinping’s rosy rhetoric about allowing markets forces to play a decisive role in allocating key resources and investment decisions.

The last two months have felt like a rollercoaster for the estimated 90 million retail investors in the Chinese stock market. With the government hoping companies would raise capital in the stock exchanges rather than seeking bank loans, novice investors bought stocks on margin with huge amounts of borrowed money, helping to create a stock bubble and runaway bull market.

Over the last several weeks the Shanghai Stock Exchange was down 30 percent. While no single factor appeared to spark the selloff, analysts attribute it to fear of slowing economic growth and the worldwide slowdown in demand for Chinese exports.

Fearing the slide might cause the economy to fall off a cliff, it was met with heavy-handed intervention by Beijing. The government cut interest rates, suspended trading for 1,400 companies, banned short sales, prohibited major shareholders from selling shares to stop the selling stampede and halted new initial public offerings.

The United States had better hope China doesn’t decide to bail out its stock market and stimulate its economy by starting to cash in some of its United States bond holdings. If that happens, U.S. interest rates will rise whether the Federal Reserve likes it or not. Of course, Japan and OPEC may step up and buy the U.S. debt if interest rates rise and U.S. bonds become more attractive.

The Chinese government’s tight control of the stock markets is not exactly consistent with allowing market forces to allocate financial resources. It’s unclear whether a government-dominated economy can have a free stock market.

International Monetary Fund chief Christine Lagarde recently said that, “China is still learning how stock markets work.” And that learning curve could have a big impact here on the other side of the world.

Originally Published: August 8, 2015

It’s a wonderful life

Those of you who’ve seen Frank Capra’s classic 1946 movie “It’s a Wonderful Life” (at least once, since it’s been a Christmas Holiday perennial on television for decades) will remember one of its most famous sequences.

George Bailey (played by James Stewart) runs a one-horse Savings and Loan bank in the All-American town of Bedford Falls. And one day he’s confronted by a group of his depositors who’ve come to withdraw their savings money because they’ve become nervous about its safety, the classic run on the bank.

He tries to clue them in on the realities of the banking business, explaining that he doesn’t keep their savings in a safe in his back office. Instead, he’s used most of the money to grant each of them affordable mortgages on their homes.

Sam’s money is in Chuck’s house. And Chuck’s money is in Dick’s house. And Dick’s money is in Sam’s house … So it goes.

With each of them able to own the homes they live in instead of having to pay rent to Old Man Potter, the hard-hearted villain who owns the leading commercial bank and most everything else worth owning in town.

What George was trying to describe to his nervous depositors is how the home mortgage and banking business worked in the “Good Old Days.”

If “It’s a Wonderful Life” were made today, its description of banking would have to be updated to reflect last month’s goings on in Cyprus. To secure a 10 billion euro bailout, Cyprus slapped a tax on deposits that ranged from 9.9 percent on amounts above E100k to 6.75 percent on deposits under E100k which translates into $130,000 (the limit for deposit insurance). It then revised the terms of the proposed haircuts to reduce the levy on smaller depositors and raise them on larger ones. In other words, they would tax the bank accounts of citizens and businesses to recapitalize the banks. Afraid that the government was coming for their cash, Cypriots ran to the bank. Much was made of the government’s attempt to get its pound of flesh from bank accounts; people had to wonder if their own money was safe. We were told Cyprus was an isolated case and it could not happen here.

But how does Cyprus compare to what’s happening to American depositors and savers? The Federal Reserve’s zero interest rate policy (ZIRP) is not a tax, but it reaches into the average American’s pockets.

And it is done for the same reason as the bank bailout in Cyprus: to save the financial system. Average Americans are earning next to nothing on their bank deposits, which are actually losing ground to inflation. Yet they can’t borrow from the bank at these ridiculously low interest rates. Maybe Cyprus doesn’t look so bad after all.

ZIRP sets a dangerous precedent. It suggests that governments are not above taking money from depositors to pay for bailout packages. If deposits are not safe from politicians, why should you trust any bank?

ZIRP has been confiscating the savings of Americans for the past five years.

The average interest on a savings account is less than 0.25 percent, a 10-year government bond yields less than 2 percent and inflation adjusted returns on six-month bank CDs are 0 percent. Average Americans have no safe place to park their money and collect a decent return. Is the difference between these returns and normal interest rates equivalent to a tax? In Cyprus, it was a one- time hit to depositor, in America it happens more slowly.

This blow to traditional savers harms the working class, discourages savings and induces some to speculate in the stock market and reach for higher yields on riskier investments. In America, savers aren’t an endangered species; they’re all but extinct.

originally posted: April 20, 2013

The Federal Reserve and paper money

A couple of weeks ago, the Federal Reserve announced that it will continue printing money to keep interest rates near zero until the headline unemployment rate drops below 6.5 percent, provided inflation does not rise above 2.5 percent. The Fed expects to continue this policy until the end of 2015.

The Fed is focusing on job creation by putting its foot on the monetary accelerator to spur consumer spending and housing purchases. Last month’s jobless rate was 7.7 percent, down from previous levels but still high by historical standards. Even though the recession officially ended in December 2009, unemployment has not been below 6.5 percent since September 2008.

The headline unemployment rate to which the Fed has attached itself actually declines as more people abandon hope of finding a job. The unemployment rate dropped to 7.7 percent in November because about 351,000 people left the workforce. lf the same percentage of adults were in the workforce as four years ago, the headline unemployment rate would be 11.1 percent.

To further accelerate hiring, the Federal Reserve also announced that it would continue its monthly buying binge of $85 billion in long-term Treasury bonds and mortgage-backed securities. To do this, you have to print a whole lot of money.

The Fed’s objective is to push long-term interest rates even lower. It’s not easy, considering that the 10-year Treasury bond is trading at 1.8 percent – less than inflation, which has averaged 2.3 percent over the last four years. Years after moving interest rates to near zero in December of 2008, the Fed is still redistributing income from savers and to borrowers.

The Fed’s catechism is that this will reduce already-low mortgage interest rates, which will help spur a housing recovery, which will lead the economy out of its doldrums. So much for claiming the government doesn’t pick winners and losers in the economy.

Sure, the housing market is on a slow road to recovery. But tight credit is standing in the way of a more robust housing recovery. Too many potential homebuyers cannot access interest rates that are at nearĀ­ historic lows. Potential buyers need pristine credit to get a mortgage because banks are afraid of owning the loan again if a borrower defaults.

If the federal government were serious about fixing the housing market, it would arrange massive refinancing at today’ s low interest rates for those who owe more on their homes than the structure is worth. That would give millions of homeowners more spending cash to lift the economy. We did, after all, spend more than 700 billion taxpayer dollars to bail out the banks without nailing any hides on the shed door.

The Fed’s near-zero interest policy also masks the real cost of financing trillion-dollar annual deficits that have become the norm. Low interest rates are an incentive for the federal government to continue borrowing at record levels. If the Federal Reserve were serious about getting the Obama administration and Congress to address the debt and enact fiscal policies to stimulate the economy, it would not keep enabling them with cheap money.

The flood of money from all over the world has helped push down the interest rate the U.S. Treasury pays to 50-year lows. But this ability to borrow enormous sums at incredibly low interest rates cannot and will not last forever, even if no one can say exactly when the day of reckoning will arrive.

Even the mighty U.S. government cannot assume it will always be able to cheaply borrow whatever it needs. Future Americans sending an unprecedented chunk of their incomes overseas to pay down debt means spending much more on our past than on our future. We should invest in education, R&D, infrastructure and addressing the job-skills deficit, not in robbing future generations of the opportunities we enjoyed.

originally published: December 27, 2012