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.