Tuesday, September 30, 2014

The Fed, Persistence, and Global Imbalance

Has the world gone crazy? Congress decided to pass a continuing resolution for the budget without all the usual muss and fuss. Obama is being quietly applauded by many people in both parties for his stronger military stance in Syria. Soon we will read that Hillary Clinton and Rush Limbaugh are quietly dating.

I take all this personally as a slight against macroeconomics. Macro has clearly gone persona-non-grata. I can’t even find lonely shut-ins willing to talk about recessions or hyperinflations.  Apparently someone contacted the Fed and asked them to take up the slack and say some incomprehensible things. Have you read some of these stories? One line of thought is that the markets are ignoring the Fed. EVERYONE knows the Fed will soon start increasing interest rates so what is there to get excited about? Another line quotes experts who are absolutely sure that as soon as rates rise, the economy is going to return to a recession. The stock market mirrors these divergent views from day to day, 

What makes all this the more complicated and confusing is that the Fed has not announced when or if it will begin to raise rates. Forward guidance is tossed around as if it were a quarter-pounder with cheese. Honey, I am thinking of losing weight. Since you baked all those cookies I will have to eat them but be sure that if you do bake more cookies I will not eat one of them. You can count on that. 

Janet Yellen the head of the Fed recently said that while she does not see interest rates rising anytime soon she is definitely on to the possibility that once the overall economy returns to normalcy, rates will begin to rise and she will have to let them rise. Some people in the market today find that reassuring. If the economy is normal, then it seems silly to continue trying to keep interest rates near zero.  Bravo.

Of course there is more to it. The overall economy to you and me looks a lot like a huge elephant looks to a tiny ant crawling on the elephant. That ant cannot see the whole elephant and its idea of an elephant will be based on what particular part of the elephant it finds itself. Charles – be nice. Some of you guys are coming from a perspective wherein you think the economy is very fragile. You can point with vivid imagery and color to a lot of deficiencies in productivity, labor markets, and so on. 
You see bubbles about to burst. To you, any admission that interest rates are going to rise translates into weak seams turning into cracks and crack-ups.

So where are we really? As I said, no one knows the whole elephant and no one knows how much pressure the economy can withstand. But that doesn’t mean one cannot hold an opinion and mine is that rates will not spike upwards and the economy will withstand less pronounced increases.

Let me explain and support this forecast with a few ideas. First, the fifties were not good at forecasting the 60s nor were the 60s a good way to predict the 70s. Macroeconomics has grown and changed as history required. While much of the current models is valuable, there are key parts that will need changing before Macro leads to better predictions in the future. Models predicting that higher interest rates will doom us may be very wrong. Second, given the financial crisis and the following recession and slow growth period, I am betting on inertia or persistence to dominate the near future. Your spouse has persistence. Your spouse will remind you to push the toilet seat down every time you go to the toilet. 

Persistence in the economy means that a little healing from yesterday permits a little more healing today. The world economy got a huge smack in 2007/08 by way of a financial crisis. Such is NOT the kind of macro shock that can be fixed with a little tax here and some government spending there.  Durable behaviors guiding saving, investing, and other fundamentals got whacked. Financial hits take time to heal. When your savings have been depleted it takes time to return to financial health. For some the return has taken many years. For others there are still many years left to go. Then you add all the new regulations affecting a broad swatch of financial markets and you create even more impact and uncertainty with regard to timing. It is now late 2014 and we are well into that game. It should unfold on its present course.

Finally is the idea of relative strength. It is no secret that as we in the USA are lumbering along, some other major economic players are in much worse shape. Whether we look to Europe, Asia, or South America it is hard to see anything like US growth.  This means a lot of things. But one thing is sure – we are a long way from the kind of global synchronized economic expansion that raised prices and interest rates in the years before the financial crisis. New to our policymakers in 2014 is the idea that US economic growth will not be accompanied by growth elsewhere. Thus we can grow and have ample global sources for commodities, equipment, savings, labor and so on. We will and can continue to lumber ahead without the usual business cycle drag of significantly higher inflation and interest rates.

The markets are correct to ignore the Fed’s multi-headed hydra. The Fed has a lot of mouths speaking these days saying a lot of different things. No matter what Janet Yellen says, rates will rise in the near future but they will not rise enough to cause major disruptions. The Fed has the luxury of a little time to get rid of excesses. It should use that global blessing to get its balance sheet in balance. Waiting too long to stop ISIS was a mistake. Waiting too long to let interest rates rise won't be the right decision either. 


  1. I must agree with your very astute assessment.....do I get an A?
    As dumb as they may seem at times, I believe that not one person on the Fed board will support major increases in interest rates in one swell foop. When/if it happens, it will be a gradual increase to a pre-determined target. After the dust settles from that one, there may be another small increase and so on.The problem will be controlling the lending institutions whose only goal is to make money, and they do that through the rates they charge for loans. Their coffers are stoked with all of those excess dollars, and they're ready to rock and roll. I'm sure there's an established ceiling that they can't exceed, but they'll certainly want to push toward it.
    "If" doesn't play too much in the deal. We all know it's just a matter of when. It should be sooner than later.

  2. Dear Fuzz, You are always an A student! One thing you are minimizing is the force of competition. Yes bankers are stoked but the conditions are not in their favor, and therefore they have little market power to force rates up. My point in the blog is that the coming year there is no big pressure to force rates up in large amounts.The Fed will allow rates to rise in parallel with the market forces. The Fed will follow, not lead. I just want them to let the process get started. Waiting will complicate things.

    1. Dear Prof, thanks for the A!
      Since we now are down to..what...about 3 or 4 major banks, there's about as much competition as there is in the airline industry. Personally, I can see more collusion than competition. There's a rush to nickel and dime us with fees just as the airlines have so there won't be any real choices.
      I love competition, but I see the field narrowing and there won't be much difference between the remaining humongous banks until they bring back that great practice of offering a free toaster with every account opened.

    2. Fuzz, I loved the days of toasters. There are still a lot of banks but I get your drift about concentration. But keep in mind that banks compete against S&Ls, shadow banks, and foreign entities. And of course collusion is illegal. I am guessing that any bank that willy nilly starts raising loan rates will feel the chill of competition as others undercut them. But on this point I am open to watching how all this develops in the next year. My post argues that rates will not zoom upward in the near future even as the Fed begins to tighten. I'll bet you a Hoosier breaded tenderloin on the outcome.

  3. Fuzzy, I am in agreement with your assessment. Banks will ( become looser with their credit) lend more as rates climb which in turn will enable all of those whose paychecks have remained flat to use credit to supplement the difference. Investors will see other things to invest in because the rates will be higher. On the other hand ROIs will be further out so capital expenditure may become weaker.

    REMEMBER...the average recession in our capitalistic system is 7 years from peak to peak . Use the math 2014 - 2007. There may be other causes but this slow growth pattern will help temper what ever recession may come. REMEMBER we still have a huge amount of people either underemployed, looking for jobs or not looking for jobs...a much large group than in any other time than the Great Depression. Some are technically displaced, some are under-educated and some just do not care. There has been a massive transition in the social and economic framework of our economy since 1998. We do not know where this is going.

    Dr D...are there any interesting books on where this is all taking us.?

    1. James I never knew a time when people knew with much certainty where we are headed. Evil always lurks within and now is particularly uncertain. I don' usually trust books written be people who pretend to know the future and today I know of few books like that worth reading. I like the book by Nassim Taleb called AntiFragile.

  4. Dear LSD. I’ll be nice. BTW, Pat tonight called me out for not lowering the toilet seat . . . geese, just forgot once in 39 years . . . but can she turn off lights when she leaves a room? . . . . no-o-o-o-o-o, of course not.

    I’m confused, conflicted, and bewitched with chat-chat-chatter from lots of folks with differing opinions of whether the economy is good, bad, still in recession or not, going up, down, or sideways. Recently the GDP figs said revised reported growth was negative but now says future growth is on track north of +4.5%. Go fig. (From whence do they get these numbers? Are the inmates in charge?) US stock markets seem oblivious to much of this chatter but sensitive to job reports, unemployment figs and new claims, perceived (or real) global chaos, and Ebola. I think a good barometer is the number of new jobs created—which has been flaccid—and until job creation exceeds 300,000 per month or more consistently I think low/no pressure on payroll will keep inflation at bay and rates will not rise.

    Fuzz and James mentioned banks’ rates relative to lending and that they’re chomping at the bit to lend when rates rise. But, not mentioned is tight lending guidelines resulting from over-correction following loose lending practices following liberals’ success in convincing everyone that everyone should own a home—so much for another example of failed liberal social engineering. Yes, the banks are sitting on a pile and rates are low but they won’t lend until sanity—can we say lending guidelines pre-CRA and Jimmy Carter?—returns to credit markets.

    Until then govomit policies will continue to dominate rates rather than let the market determine them. Yellen el al git your mitts off the reigns and the pony ride.

    1. Despite our common gender Charles I am reluctant to enter a comment on your marital issues. Safe to say, however, is that you got my drift about the meaning of persistence.

      Apparently you were not so swift on the elephant example. There will never be a time when all people agree on the elephant or on the strength of the economy. Your point about employment is well taken but employment is no better than GDP in measuring an aspect of economic growth. Like you I am not bursting with pride about the economy but I do think that persistence is strong and will keep us lolly-gagging along. All those new taxes and all those regs cannot help economic growth. I agree. That's why I argued that the Fed needs to finally takes its foot off the pedal.