The Three Biggest Myths about the Fed Rate Hike

Dec 18, 2015

27

Paris, France

The Fed did as expected...

It announced it would raise its key rate by a quarter of a percentage point to 0.5% and gradually raise it up over the next three years.

Reports the Financial Times: 'Historic gamble for Yellen, as Fed makes quarter-point rise.'

If all goes well, we'll be back to 'normal' in 2019 - 10 years after the long emergency began!

US stocks rose on the news, with the Dow up 224 points - or about 1.3%.

False Premise

Those who predicted panic were wrong. (Surprises rarely come when they are expected.)

But wait...

How does the Fed know what a normal rate will be in 2019? Won't conditions change?


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Besides, there are sidewalk astrologers and mall palm readers with a better record of market forecasting than the Fed.

To borrow a phrase from George Soros, our mission here to 'find the trend whose premise is false and bet against it'.

Is it true that the Fed is really going to follow through with its promise to return interest rates back to normal?

Is it true that terrorists are out to get us?

Is it true that Donald Trump is a fool?

Of course, we are all fools...but some more than others. The wise man is the one who knows he is a fool. For our part, we deny it. And we resent readers who remind us.

But we admit to being wrong, from time to time. (Any man who has been married for as long as we have must be accustomed to this kind of admission.)

And since investors so heartily endorsed the Fed's move, we will re-examine our position.

The premises of the rate increase are several...

...that the Fed knows best what interest rate is good for the economy...

...that a recovery is sufficiently established to permit an end to the emergency micro rates of the last seven years...

...and that otherwise everything is more or less hunky-dory.

Dollar Recession

And they are all false?

We dismiss the first one as poppycock.

No serious economist - if there are any left - would believe that the Fed can do a better job of setting the price of credit than willing buyers and sellers.

As to the second premise - that the recovery is solid - we present evidence to the contrary practically every day.

Today, we submit to the jury some additional facts:

  1. Last month, US industrial production fell more than any time in the last three and a half years. This marks the eighth monthly decline in 10 months. This slowdown is shadowed overseas by what Deutsche Bank describes as 'a huge global dollar nominal GDP recession - the worst since the 1960s'.
  2. According to the Fed, there are now 61 million people of working age in the US who don't have jobs. That's out of 204 million people between 15 and 64 years old. So, if you pass five people on the street, the odds are that one and a half of them is jobless.
  3. The 'labour participation rate' - the amount of people in the working-age population either employed or looking for work - is at its lowest level since 1977. For men, it has never been lower.

If it were true that the economy was in good health, how is it possible that men would have a harder time finding a job than ever before?

When the Going Gets Tough

Now, we turn to the third premise - that everything else is more or less hunky-dory.

Supposedly, in this wide world of everything that is not directly under the Fed's control, or included in its inventory of conceits and fantasies, there is nothing that poses a serious obstacle on the road to normalcy.

If this were true, we are wrong. Because our guess is that the Fed is trapped and that it cannot continue down this road for long. It is only a matter of time until it runs into trouble.

What kind of trouble?

You can get any kind of 'facts' you want. But on the road to normalcy, the Fed is bound to encounter a normal stock market selloff or a normal recession.

Ms Yellen has dismissed worries of a recession. But unless the Fed has triumphed over the business cycle - which we doubt - a recession will appear sooner or later.

In the face of such adversity, how likely is it that the Fed will persevere?

The Fed's future actions are 'data dependent', says Yellen.

But imagine if Christopher Columbus had taken a 'fact-dependent' voyage across the Atlantic.

Fact No. 1: He ran out of food.

Fact No. 2: His men were sick and dying of scurvy, malnutrition, and other diseases.

Fact No. 3: India was not where he thought it was.

Any one of these facts, presented to him forcefully by his crew, would have been enough to cause him to turn around.

When the going gets tough, 'fact-dependent' travellers go home.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

Disclaimer: The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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2 Responses to "The Three Biggest Myths about the Fed Rate Hike"

Niky Kotian

Dec 18, 2015

All these talks of reducing interest rates to boost the progress is valid only in countries with strong social security system I.e. where there is regular pension for retirees & free good medical free service for such people.
In a country where people paid their income tax honestly all their lives & have nothing but interest income (again taxable) to live on- either because they have no children, or children disown them or are too proud to ask their children, it is simply a tool to drive them to suicide.....if that is what the government wants to appease those selfish industrialists who want to do their business with public money, so be it !

Like 

Niky Kotian

Dec 18, 2015

All these talks of reducing interest rates to boost the progress is valid only in countries with strong social security system I.e. where there is regular pension for retirees & free good medical free service for such people.
In a country where people paid their income tax honestly all their lives & have nothing but interest income (again taxable) to live on- either because they have no children, or children disown them or are too proud to ask their children, it is simply a tool to drive them to suicide.....if that is what the government wants to appease those selfish industrialists who want to do their business with public money, so be it !

Like 
  
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