Feb042015

Why the federal reserve will not raise rates in 2015

Conditions don’t warrant raising interest rates, and the risks of doing so outweigh any perceived reward.

From the beginning of the Great Recession, many concerned citizens, and particularly the wealthy, feared the government and federal reserve would institute policies that would devalue the currency, cause bond prices to collapse, and create hyperinflation. With near-zero inflation, a rallying dollar, and the 10-year bond yielding record lows, it’s obvious none of the predictions of economic doom have come to pass. Janet_Yellen_easy_Job

The only reasons the federal reserve would have to raise interest rates is a decline in currency value, crashing bond prices, or high inflation; since we have none of those, only the fear of this happening in the future would prompt a rate increase.

The federal reserve is not a proactive entity. They will not raise rates until forced to do so reactively, and nothing in the current economic circumstances suggests any reaction is necessary. Most influential economists, right or wrong, warn against any change in economic policy that might derail the economic expansion.

Larry Summers warns of epochal deflationary crisis if Fed tightens too soon

Former US treasury secretary also says eurozone QE has come too late to lift the region off the reefs on its own.

By Ambrose Evans-Pritchard,  22 Jan 2015miss_HELOC_money

The United States risks a deflationary spiral and a depression-trap that would engulf the world if the Federal Reserve tightens monetary policy too soon, a top panel of experts has warned.

Deflation and secular stagnation are the threats of our time. The risks are enormously asymmetric,” said Larry Summers, the former US Treasury Secretary.

What does he mean that the risks are asymmetric? It’s a bit like driving on a cliff-side road. If you leave the road to one side, you hit the side of the mountain and crash your car; it’s bad but not fatal. However, if you leave the road to the other side, you plunge off the cliff to your death. That’s an asymmetric risk.

Is inflation and deflation truly an asymmetric risk? Based on the experience with inflation and deflation in the 19th century, policymakers deemed that it is. The federal reserve was largely created to prevent a recurrence of the deflationary bouts of the 19th century, and despite criticisms to this approach, the federal reserve still exists 100 years later, and they still act more strongly to avoid deflation than to curb inflation.

inflation-1872-present

And our federal reserve is not alone in this practice. If you like very long term charts, check out this one from the UK:

15-02-02_inflation_since_1510

There is no confident basis for tightening. The Fed should not be fighting against inflation until it sees the whites of its eyes. That is a long way off,” he said, speaking at the World Economic Forum in Davos. …

Any error at this critical juncture could set off a “spiral to deflation” that would be extremely hard to reverse.

Economists live in fear of a repeat of the 1937-1938 recession. The American economy took a sharp downturn in mid-1937, lasting for 13 months through most of 1938. Industrial production declined almost 30 percent and production of durable goods fell even faster. Unemployment jumped from 14.3% in 1937 to 19.0% in 1938. Manufacturing output fell by 37% from the 1937 peak and was back to 1934 levels.federal_reserve_economist

Keynesian economists assign blame to cuts in federal spending and increases in taxes at the insistence of the US Treasury. Historian Robert C. Goldston also noted that two vital New Deal job programs, the Public Works Administration and Works Progress Administration, experienced drastic cuts in the budget which Roosevelt signed into law for the 1937-1938 fiscal year. Monetarists, such as Milton Friedman, assign blame to the Federal Reserve’s tightening of the money supply in 1936 and 1937.

Not everyone agrees with the Keynesian interpretations of the causes of the recession, but most people empowered to make decisions in Washington do, so it’s unlikely they will risk a repeat of the 1937-1938 recession if the price is only a little inflation.

This next issue seems unrelated to the first, but it provides another reason I believe the federal reserve will allow inflation to grow large and go on for longer than most anticipate.

Why mortgage debt threatens boomers’ retirements

Published: Feb 2, 2015 12:02 p.m. ET

A new study finds that, by many measures, debt levels among Americans age 55 and older continue to climb, putting millions of families—and their homes—at risk.

The report, “Debt of the Elderly and Near Elderly, 1992-2013,” comes from the Employee Benefit Research Institute in Washington, D.C. On the positive side, total debt payments as a percentage of income within this group fell to 10% in 2013, from 11.4% in 2010. At the same time, average debt decreased, to $73,211 from $80,465.

carry_mortgage_debt

Overall, though, more older Americans find themselves in debt. The percentage of American households where the head of household was age 55 or older that had financial liabilities increased to 65.4% in 2013 from 63.4% in 2010. In 1992, the level was 53.8%.

What’s more, the percentage of these families with debt payments greater than 40% of income—a traditional signal of excessive liability—increased to 9.2% in 2013 from 8.5% in 2010.

The upshot: The “percentages of families whose debt payments are excessive relative to their incomes are at or near their highest levels since 1992,” the report states. “Consequently, even more near-elderly and elderly families are likely to find themselves at risk for severe changes in lifestyle after retirement than past generations.”

If the Baby Boomers carry too much debt into retirement, how will they cope? Since they are retired, they can’t work harder, change jobs, or otherwise increase their income, so it only leaves one viable option: they lobby politically for increased benefits, and since retired people vote at much higher rates than younger workers, politicians will accommodate them.retirement_savings

The political pressure to increase retirement benefits puts the Baby Boomers in direct conflict with Millennials and everyone still working in between. Politicians will want to take the path of least resistance, which won’t be raising taxes, so that leaves only one alternative: inflation.

Inflation does two things for over-indebted retirees: first, it makes the currency less valuable, so they are repaying debt with less valuable dollars, and second, it inflation increases retiree income through their cost-of-living adjustments from social security.

Inflation allows politicians to stealthily tax the working class and avoid political repercussion for direct tax increases, and it allows seniors to devalue their debts and increase their incomes. The solution solves everyone’s problems — except for the holders of currency and wealth who will see their holdings diminish due to inflation.

The political left will embrace inflation specifically because it reduces the value of wealth. One of the biggest problems of modern times (according to the political left anyway) is the huge divide between the wealthy and the middle class. Sustained inflation reduces this problem by raising wages for the middle class and reducing the value of stored wealth. Judgements about the morality of this approach aside, it’s politically palatable, and therefore, I believe that’s how the future will play out.

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