Lowering interest rates is not necessarily a bad thing. It can make borrowing cheaper, which – at least in theory – will stimulate business investment. It can weaken the dollar, making American goods cheaper abroad. It can lower payments on the federal debt.
The problem with lowering interest rates is that eventually they have to be raised again. If rates were to remain at zero indefinitely, the Federal Reserve Board could not lower them to stimulate the economy during a recession, unless it created negative interest rates, which cause a whole new set of economic problems.
And history says a recession is likely to come sometime soon. The current recovery, which has frequently been described as anemic, celebrated its eighth anniversary in June. Now in its 97th month, it is the third longest recovery on record. The average recovery since the end of World War II has been 58 to 61 months.
While the length of the recovery may not determine how long a recovery will last, when unemployment drops low enough to spur inflation, the probability of a recession climbs. And unemployment is allegedly at a 16-year low of 4.3%.
“Expansions, like Peter Pan, endure but never seem to grow old,” according to Fed economist Glenn Rudebusch.
But the current expansion has much more in common with Peter Pan. It’s a fairy tale. And the Fed has run out of fairy dust.
The Fed’s Conundrum
The conundrum the Fed faces is that as it raises interest rates so that it will be able to drop them in case of a recession, it may actually cause one.
“Tightening monetary policy further will simply accelerate the time frame to the onset of the next recession,” according to Lance Roberts of RealInvestmentAdvice.com. “In fact, there have been absolutely ZERO times in history that the Federal Reserve has begun an interest-rate hiking campaign that has not eventually led to a negative outcome.”
And, depending on how you look at the numbers, the economy may not be nearly as strong as the Fed has been indicating. While Fed Chair Janet Yellen said that “economic activity has been rising moderately so far this year” when she announced the most recent rate hike, there is plenty of evidence to the contrary.
“For the 13th straight week,” Zerohedge noted recently, “U.S. economic data disappointed (already downgraded) expectations, sending Citi’s U.S. Macro Surprise Index to its weakest level since August 2011 (crashing at a pace only beaten by the periods surrounding Lehman and the U.S. ratings downgrade). The last time, U.S. economic data disappointed this much, Ben Bernanke immediately unleashed Operation Twist … but this time Janet Yellen is hiking rates and unwinding the balance sheet?”
What about that low unemployment rate? Even CNBC acknowledges that the much higher U-6 rate of 8.4% is a more accurate measure.
So, Roberts wrote, “despite the clear evidence that economic growth is hardly running at levels that would be considered ‘strong’ by any measure, the Fed is ‘tightening’ monetary policy. This is ironic considering the ENTIRE PURPOSE of TIGHTENING monetary policy is to SLOW economic growth to keep inflationary pressures at bay.”
Soft Landings Are Hard To Come By
Under the best of circumstances, it is difficult to bring interest rates back to normal levels without causing a recession. This time, the Fed is attempting the feat under extraordinary circumstances. It is bringing interest rates back from historic lows, as they have remained near zero for the length of the recovery. And it is doing so as it considers unwinding its $4.5 trillion bond portfolio.
What could possibly go wrong?
Soft landings are like pet unicorns. Everyone wants one, but no one has ever seen one. That the Fed will be able to achieve one, given current circumstances and its inability over the past seven-plus years to help the economy achieve significant growth, is about as credible as Peter Pan.
In fact, rate raising could already be having a negative impact.
“With interest rates increasing, I would point out that market behavior has changed,” Duane Norman wrote on Free Market Shooter. “The meteoric rise has stalled. In the past few months stocks have barely budged 1 percent either up or down per week. Except for last week when something strange happened; markets suddenly dropped nearly 400 points in a single day.”
Media Will Blame Trump
As the stock market rose to unrealistic levels in recent years, it was generally acknowledged that the Fed was responsible for the rise. If the stock market falls or if the economy enters a recession will the Fed take the blame?
It’s highly unlikely. Consider the media reaction to the 400 point drop noted above.
“Multiple news outlets responded by immediately connecting the drop to Trump and the absurdity surrounding the ‘Comey memo’ — a memo which no one in the public has seen proof of,” Norman wrote. “The claim is that this level of turmoil around Trump might lead to impeachment and that the threat of impeachment would kill the stock market bounce which the media also claims was driven by Trump’s promises of corporate tax cuts. It’s a lie built on another lie.”
Meanwhile, efforts to reform taxes and deregulate drag on. If they eventually succeed, they could delay the next recession and give the stock market another boost. If they fail, as Norman wrote, “any downturn within the system will indeed be blamed on the Trump administration.”
Welcome to Never Never Land.