The economics world is all abuzz these days about U.S. interest rates. No doubt that’s largely due to the release today of the minutes of the last (June) big Federal Reserve meeting on the state of the economy, finance, and monetary policy. But there have been some other contributors as well:
> the stock market’s unusually low levels of volatility;
>a New York Times article noting the astonishing, and surely related, rise in the price of stocks and nearly all other classes of assets recently – risky and non-risky alike;
>a new report from the Bank of International Settlements (a grouping of the world’s central banks) warning that the virtually non-existent rates and thus minimal bond returns created by unprecedented world-wide (or nearly so) central bank easing are producing a massive level of bad, unproductive investments everywhere you look;
>and a post by New York Times columnist and Nobel laureate Paul Krugman challenging claims by the BIS and others that rates are too low.
If I knew where rates should be, much less where they’re heading, chances are I’d be too busy deciding how to spend all my newfound wealth to blog very often. For the record, my own sense is that they’re going nowhere fast. (And, full disclosure, yes, that strongly influences how I invest.) I’m not ignoring the impressive evidence indicating that inflation is actually considerably higher than the official data tell us – which would make a significant Fed rate hike in the foreseeable future almost inevitable
But as I see it, there’s little reason to believe that these pressures are resulting from stronger economic activity and, by extension, the overly easy money supposed to be fueling it, or about to fuel it. Rather, whatever higher prices consumers have seen seem to stem mainly from bad weather that’s making many foodstuffs more expensive, from geopolitical crises that are casting doubt on future oil supplies, and from a housing sector juiced disproportionately by wealthy foreign buyers.
In fact, one of the main classic engines of inflation, higher wages, is rapidly becoming a distant American memory. Far from rising, U.S. wages in the private sector have actually fallen during the recovery when you adjust for official inflation rates, and the latest (May) data even show that they’re down month-on-month and year-on-year. (I’m omitting public sector wages because they’re set by government fiat, not market forces.) And if wages are falling in real terms – i.e., lagging the inflation rate – it’s hard to argue that they’re fueling inflation, or will do so any minute. My June 10 post provides background and context.
The upshot (sorry, New York Times!) is that the U.S. economy appears to be falling victim to a combination of higher prices and humdrum-at-best growth. The resulting real pocketbook squeeze on most consumers will keep sapping the economy’s strength – because a critical mass of Americans won’t be prospering and thus shopping enough to spur businesses to start producing more, and because, despite low interest rates, so many Americans have simply been locked out of credit markets. In principle, business spending could help fill the gap. But it’s likely to stay subdued because of that weak consumer demand, and because the ongoing credit flood makes all the lousy, unproductive investment look so much more attractive.
All of which means, if anything, that either the Fed will have to start thinking seriously about driving the short-term interest rates it directly controls below their multi-year zero level, or it will have to reconsider its current wind-down of the quantitative easing bond-buying program.
In other words, America may have sunk into the secular economic stagnation described starting late last year by former Treasury Secretary and top Obama aide Larry Summers. In his view, that means that inflating more asset and/or credit bubbles is the nation’s only hope for stimulating even minimally acceptable growth.
As I’ve written previously, the U.S. economy has far better options – chiefly, reducing the trade deficit. More exports and fewer imports (the latter are easiest by far to control) will increase economic activity without unaffordable tax cuts or equally unaffordable government spending. A big infrastructure spending program, as widely noted, could help greatly, too — especially if the materials and equipment are overwhelmingly American-made. Sadly, both ideas are far off Washington’s agenda. That should keep rates pretty much where they are for the foreseeable future – and possibly send central bank printing press prices through the roof.