Since 2013 many of us have been puzzled: Why has by the Federal Reserve failed to raise interest rates? We have heard the explanation — primarily that rate decisions are "data dependent." Yet often, the metrics employed to gauge progress have later been abandoned, just as the initially stated goals are approached. Originally the goal was to reduce unemployment to 6 percent, from 10 percent. The revised goal is now 5 to 5.2 percent, labeled by the Fed as "full employment."
The Fed has focused too much on the rewards of zero rates and too little on the risks of an asset bubble and accelerating debt. Yet we see a looming reminder of the latter in current corporate and student debt. On Aug. 10, on Bloomberg TV's "Surveillance," Alan Greenspan himself warned of a "pending bond market bubble."
The Fed acknowledges that it is in uncharted territory. Its stated reason for an easy money policy was to move investments from safe to riskier ones and thereby boost economic productivity. The results, at best, were lackluster. Will the Fed now choose to raise rates in September? Or December? Or later? Could politics be playing a role? Will the Fed stretch the loose rates to after the 2016 national elections?
Why is it taking the Federal Reserve so long to raise interest rates? This is a mystery to many of us who look at the data since 2013. We clearly see a modest recovery: Stock prices are at record highs, household net worth is at record highs, unemployment is at a low 5.3 percent and jobless benefits applications are at a 15 year low. Retail sales are also at record highs (consumer spending drives 70 percent of the economy), and corporate profits are steady.
Looking at the recent data, along with the unintended results of its unnecessarily easy money, the Fed is late, not too early, in raising rates to restore normal market conditions. Since 2013, the rewards of zero rates and accelerating corporate debt have produced declining productivity and anemic growth.
Most of today's corporate profit — new capital — is not going to capital spending for new hires, R&D, plants and equipment. This new capital is, rather, directed to mergers and acquisitions (approaching $3 trillion, perhaps reaching $4 trillion this year), corporate buybacks and dividends (estimated at $1 trillion last year), and leveraged buyouts.
This exercise in financial engineering replaces new capital spending. It does not produce new jobs.
The Fed seems to have relied too much on the rewards of zero or very low interest rates. This is what Alan Greenspan's Fed did, with devastating results. What's behind the Fed's loose-money policies? Is it worry over the developing deflation afflicting Europe and Japan, or over the long-term consequences of some new economic norm?
Have we come to the point when our faith in the market's effectiveness and resilience is so weak that we fear a 0.25 percent increase in rates will depress not only stock prices but the overall economy as well? I don't think so. Americans have long been prepared for a rise in interest rates. Some short-term, limited losses may occur. But the much greater risk is that the Fed will not act in September and, when it does act, it will not be decisive about its future actions. With this, we jeopardize the return to some semblance of normalcy and a market-driven economy.
Zero interest rates serve as a demand stimulus. But the borrowing and the accompanying debt it produces burdens future generations. The Fed's stimulus efforts have flowed largely to financial engineering, not to the capital spending, job creation and wage increases that would contribute to a healthy economy. Bottom Line: Even if the Fed makes a few small rate increases in the next year or so, its expected continuation of a loose-money policy will perpetuate the financial engineering and enlarge the corporate debt. The big risk now is an asset bubble and an investment bust. Recall that the Greenspan Fed promised to hold the interest rate at one percent, and we remember the results.
Perry L. Weed, attorney and founder/director of the Economic Club of Annapolis. His e-mail is firstname.lastname@example.org.