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Can the US economy survive more of the Fedís monetary support?

By: Steve Saville, The Speculative Investor

 -- Published: Monday, 10 August 2015 | Print  | Disqus 

Everybody knows that the Fed will eventually hike its targeted interest rate. When it comes to rate hikes, the only unknowns involve timing. What hardly anybody knows is that the Fedís interest-rate suppression has damaged the economy and that the longer it continues, the weaker the economy will get.

Based on the wording of last weekís FOMC statement it is still likely, but far from a certainty, that the first rate hike will happen in September. That is, the timing of the Fedís first rate hike remains unknown. The bigger unknown, however, is the timing of the Fedís second rate hike. The reason is that there could be a large gap between the first and second hikes as a jittery Fed takes its time assessing the effects of the first hike. It could also be a case of ďone and doneĒ.

There have recently been numerous comments in the press to the effect that the Fed should stay with its zero% target, the reasoning being that the US economy is not yet strong enough to cope with even the smallest of rate hikes. This is downright weird, given that the economy is supposedly now 6 years into a recovery from the 2007-2009 recession. Just to be clear, I am referring to comments that there SHOULD be no rate hike in the near future, not to comments that there WILL be no rate hike in the near future. The first type of comment is a policy recommendation based on the wrongheaded theory that keeping the Fed Funds Rate at zero will help the economy, whereas the second type of comment is based on the recognition that the Fedís senior management is guided by wrongheaded theory.

Not to put too fine a point on it, only someone who is economically illiterate could believe an economy can be helped by forcing the risk-free short-term interest rate down to zero and holding it there for years. The reality is that when a central planner distorts price signals it causes investing errors in the affected parts of the economy, and when a central planner distorts the most important of all prices (the price of credit) it leads to investing errors across the entire economy. Many economists, and as far as I can tell all Keynesian economists, havenít figured this out because their analyses are based on models that treat the economy as if it were an amorphous mass instead of what it is ó an extremely complex network comprised of millions of individuals making decisions for their own reasons.

Strangely, the commentators on the financial world who claim that the Fed should continue its Zero Interest Rate Policy havenít put two and two together. They havenít twigged that itís not a fluke that the greatest experiment in money-pumping and interest-rate suppression in the Fedís history coincided with the weakest post-recession recovery since the 1930s. Itís not a fluke because the extraordinary stimulus is the main cause of the apparent inability of the economy to get out of its own way. A former Fed chairman (now blogger) and current Fed officials routinely take bows for having brought the economy back to health, and yet over the past three years the compound annual growth rate of real US GDP has been slightly less than 2%/year using the governmentís estimate of ďinflationĒ and probably around 0%/year using a more realistic estimate of ďinflationĒ. And this 3-year period should have been the sweet spot of the post-2009 economic expansion!

To be fair, the failure to link the weakness of the recovery with the dramatic scale of the policy response is not actually strange. It is, in fact, completely understandable. After all, if the economic model to which you are totally committed is based on the assumption that money-pumping and interest-rate suppression give the economy a sustainable boost, then an unusually weak economy in the wake of aggressive intervention of this nature can only mean two things. It can only mean that the situation would have been even worse without the intervention and that the problem was too little, not too much, monetary accommodation.

Itís testament to the resilience of whatever capitalist elements remain that the Fed hasnít yet driven the US economy into the ground. There must, however, be a limit to the amount of monetary accommodation (that is, to the amount of price falsification) that the economy can withstand. I wonder what that limit is. Unfortunately, by the looks of things we are going to find out.

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 -- Published: Monday, 10 August 2015 | E-Mail  | Print  | Source:

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E-mail: Steve Saville


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