Outlook Worsened: Negative Rates from the Federal Reserve? Really?

Federal Reserve Janet Yellen
On 4 November 2015, Janet Yellen purported that the Federal Open Market Committee (FOMC) would be willing to lower the federal funds rate into negative territory if US economic conditions deteriorated further.

The United States faces many problems — a massive welfare state, complicated tax code, oversized government, over-regulated economy, and bloated education system. After a flurry of astigmatic regulation designed to promote home affordability created a $4 trillion housing bubble and ensuing financial crisis, most would hope that a nation as powerful as the US would finally get its act together. That pretence was simply false.

Since 16 December 2008, the FOMC has maintained a policy of 0% interest rates on federal funds, overnight funds traded between banks to maintain their deposits at the Fed. This was aimed to push interest rates far below Wicksellian (equilibrium) level and create another asset bubble. While this would result in another recession after a burst, the Fed has not been an organisation known to be concerned with long-term stability since the passage of the mandates set forth in the Federal Reserve Reform Act of 1977.

In addition, the FOMC maintained a policy of quantitative easing from 2008 to 2014. The policy  administered $3.5 trillion in asset purchases in the secondary market, with a goal of suppressing yields on government bonds to shift the allocations in investors’ portfolios to riskier assets such as stocks. Considering that the DJIA has more than doubled since the end of the financial crisis, QE clearly served its purpose in securities markets. In another respect, however, the program failed tremendously.

This current expansion is the slowest in the entire economic history of the United States. GDP growth has averaged 2.2% since the end of the financial crisis, far below the 1949-2007 long-term average of 3.25%. Wage growth is completely anaemic, with virtually no inflation-adjusted growth in the past six years. Government spending is approximately 40% of GDP and the country faces a regulatory burden of 12% of GDP. Despite all of these negative factors, both the Obama administration and Federal Reserve have attempted to convince the populace that the US economy is performing at an “optimal” level.

In recent months, however, many investors and consumers alike have started to discern the blatant attempts at misinformation. Equities markets are completely flat in 2015 so far and reports in consumer confidence are consistently falling. After the announcement that the US economy grew just 1.3% in the third quarter of 2015, the Federal Reserve itself began to shed its attitude of confidence and false optimism.

In the last FOMC meeting on 28 October, Narayana Kocherlakota, the President of the Federal Reserve Bank of Minneapolis, projected negative rates in the future. Many disregarded this as a deranged prediction from Kocherlakota, who is known for making erroneous statements on future monetary policy. On 4 November 2015, Janet Yellen, Chair of the Federal Reserve, claimed that the federal funds rates could be lowered to negative territory “if outlook worsened”. The radical fringe has suddenly become the voice of prophecy.

That same day, William C. Dudley, the President of the Federal Reserve Bank of New York, stated in an interview that “some of the experiences [in Europe] suggest maybe can we use negative interest rates and the costs aren’t as great as you anticipate,” referring to the disastrous negative interest rate policy set forth by the European Central Bank. Mario Draghi, the President of the European Central Bank, hinted that rates could be lowered further if the condition of Europe’s economic condition somehow gets even worse.

The harsh truth that has emerged since the end of the financial crisis is that expansionary monetary policy does not lead to higher economic growth in the sustainable sense. Expansion of the money supply and artificially lowering interest rates only serve to create an asset bubble, which is present in the US, Canada, and Europe. Negative interest rates will only make this conundrum even more difficult to rectify after the respective bubble bursts. Instead of focusing on short-term shortcuts that lead to economic malaise in the future, the West should begin fixing its long-term problems.

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Tsipras, Varoufakis, and the Schäublegang: Pension Crisis Edition

Varoufakis and Schäuble met on 27 February to negotiate a bailout extension for Greece, a nation that already has 360 billion Euros in debt.
Yanis Varoufakis and Wolfgang Schäuble, the finance ministers of Greece and Germany, respectively, met on 27 February to negotiate a bailout extension for Greece, which already has 240 billion euros in debt.

Another day, another chapter in the ongoing Greek debt crisis. While Greece’s T-bill action earlier today was a success, the yield on Greek treasury securities reached an 11-month high of 2.97%, compared to 2.75% on the last auction in February. Another issue of contention is that 262.5 million euros were non-competitive bids, mostly comprised of funds from Greek Social Security accounts.

Concerns over a Greek exit from the Eurozone (so-called “Grexit”) peaked in late February during the Troika-Greek debt negotiation showdown. Yanis Varoufakis, the finance minister of Greece, eventually struck a deal with the Eurogroup. Many in the Bundestag were hesitant to pass the bailout extension, while many in Greece were angry at the SYRIZA Party for reneging on pre-election promises. Despite the opposition in Germany to the extension, German finance minister Wolfgang Schäuble pleaded that “we Germans should do everything possible to keep Europe together as much as we can.” Greece’s exit for the euro could cause major problems for other Eurozone members by undermining the credibility of the euro.

In the past month, many issues have rose from changes in bailout programs between the Troika and Greek government. Since 2010, the European Central Bank has accepted Greek junk bonds and related securities as collateral from banks to assist refinancing operations as long as the Greek government continues fiscal reform and austerity measures. This program ended on 4 February 2015, causing disarray and worry within the Greek banking system. To quell concerns, the ECB extended to scope of its Emergency Liquidity Assistance program to Greek banks to 65 billion euros. The last tranche of bailout from the ECB of 7.2 billion euros requires that Greece meet new budgetary requirements before the assistance is paid out.

The current crisis in Greece originates from poor government policy over the past several decades. A stringent regulatory structure discourages business formation and investment. While this is a major problem across the Western world, it contributes massive weight to Greek economic malaise. Inefficient state-owned enterprises produce poor services whilst adding to budgetary deficits. Conflicting laws in the country’s legal system discourages business production through ill-conceived prosecutions. High taxes on the wealthy have encouraged capital flight and tax evasion, reducing Greek tax receipts.

In order to expiate the debt crisis situation, Greece needs to adopt a hands-off approach to economic management through privatization, deregulation, and a streamlined tax and legal system. Tsipras and Parliament cannot pay off the 240 billion euros in government debt through tax hikes or penalties. The Greek economy needs a period of economic prosperity in order to extend Treasury reserves. While this goal seems impossible at the moment, many nations, such as Vietnam and India, have utilized successful economic reform to their advantage.