It’s time for the US Fed to walk away from a bad bet

PUBLISHED : Sunday, 28 August, 2016, 1:34am
UPDATED : Sunday, 28 August, 2016, 1:54am

In light of the continued solid performance of the labour market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.

Janet Yellen, US Federal Reserve Board

SCMP, August 27

 

But not strengthened enough to for another midget 25 basis point increase in interest rates before the US presidential election in November. This would be seen as interfering in political matters.

The year 2016 is one in which earlier Fed talk had US interest rates marching steadily up. Yet it might see not a single increase at all. Don’t laugh. It could happen and, if it does, just watch the Hong Kong property market boom again.

Let’s examine the Fed general reasoning. It goes something like this: “We had a nasty shock in 2008-09 and we’re still totally at sea as to why it happened but it wasn’t our fault, honest, stop blaming us. Anyway we’re going to make sure our economy comes back to full health and we have way to do it.

“What we shall do is pinch the stock of government bonds in the market by buying them up and then locking them way through a trick we’re allowed to play on commercial banks of telling them it was they who bought these bonds, not we. Instead of calling this arm twisting, we’ll call it quantitative easing to confuse people.

“What this will do is push bond prices up which, will push interest rates down and, with a little more trickery we’ll be able to drive our version of interbank rates, the fed funds rate, right down to zero.

“Then everyone will want to borrow because it costs nothing and our economy will boom and all our troubles will be over. Ain’t that just a grand idea?”

For the answer to this question, I refer you to the two charts, each covering a period of six years. The red line in each represents the more recent past, the period from June 2010 to June 2016. The blue line represents a contrasting period from June 1994 to June 2000 before the troubles of the first decade of the century and the quantitative easing that followed it.

Yellen says US rate hike coming, but pointedly offers no timetable

Thus in the first chart the red line at the bottom shows you the fed funds rate which the Fed has hammered right into the floor for the last six years. The blue line shows you what it was 16 years earlier, an average of just under 6 per cent throughout, reflecting the old adage that political stability is defined as money at 6 per cent.

Going by Fed theory, gross domestic product growth in the US should have boomed as a result of low rates. Instead, as the second chart shows, it has been far lower in the last six years than over our contrast period with much higher interest rates.

The Fed theory conclusively fails. It’s time to walk away from a bad bet.

But the Fed won’t, and my bet is that rates will stay low and our property market will boom again.