To Raise or Not to Raise? The Fed’s Dilemma

Interest rates

Insanity is doing the same thing over and over again, but expecting different results.

Rita Mae Brown

The US Federal Reserve is torn. As evidenced by their July meeting minutes, they are not sure what to do. They have been keeping rates low for years to boost the economy. Yet nothing is happening.

Now they are hinting they want to raise interest rates. But they don’t know if this is a good idea.

You see, employment figures have increased since their last meeting. In fact, the US is nearing full employment. Yet manufacturing production has changed very little. And the balance of trade keeps widening.

The economy — and inflation — should be growing at a faster pace. But inflation is being kept down by low energy prices. The Fed expected inflation would stay low in the short term, yet they didn’t think it would stay this low. And it looks like from their meeting’s minutes that they intend to keep interest rates low for some time, while they take a ‘wait and see’ approach.

‘Committee expects that economic conditions will evolve in a manner that will warrant only gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.’

The tools that worked so well in the past to boost the economy are no longer working. And now they are not certain if the good news on employment figures are enough to bring an interest rate hike.

The Fed is now facing a confidence crisis. Central Banks from China, Japan, France and Brazil are dumping US debt as quickly as possible. In the largest US sell off since 1978, according to CNN.

Allianz chief economic adviser Mohamed El-Erian told the Australian Financial Review: ‘There is a growing number of people who are realising that in terms of delivering economic outcomes, the Fed and other central banks are becoming less influential.

An ageing population and low productivity may be slowing growth. We are also living in a more technological world where companies are investing less in physical assets.

The Fed has been keeping rates low since 2009. They are currently at 0.5%.  There is not much room left to cut interest rates.

The Fed is running out of ideas. Like Hollywood — who keeps on making remakes of its successful old movies in the hopes of a blockbuster — the Fed keeps reusing the same formula. Yet they are not getting different results.

The debate has prompted Yellen to schedule a big speech today. And the markets are reacting timidly to this announcement.

Yet the US Fed is not the only one realising that the old policies are not working. Europe, Japan and even Australia are experiencing the ineffectiveness of their traditional tools. Low interest rates, low inflation and low growth seem to be the new norm around the world.

And the RBA may have the same dilemma in their next meeting. The RBA has recently cut interest rates in Australia. Yet it seems that all this has done is to boost the property bubble in Sydney and Melbourne even more.

All this long term cheap money cannot end well.


Selva Freigedo,
For The Daily Reckoning

The Daily Reckoning’s Vern Gowdie believes we’re already at the beginning of the next major crisis.

Vern is the Founder of The Gowdie Letter and Gowdie Family Wealth advisory services. As one of Australia’s top financial planners, Vern says the coming crisis is already in motion.

Australia has gone through two credit bubbles in its history. The third, and latest, has built up over the past 65 years. When it pops, the impact will leave a lasting mark. One that makes the 2008 financial crisis look like child’s play.

The fallout of this crash could damage your wealth. But you can safeguard your wealth from the worst effects of the coming crisis, provided you act now.

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Selva Freigedo

Selva Freigedo

Selva Freigedo

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