Is the Fed dong the
right thing by not increasing the interest rates??
Foreign Portfolio Investments (FPI) have been
negative in the last two months, yet the RBI has decided to toss for growth and
lowered the rates by 50 basis points. The uncertainty regarding the Fed
interest rate hikes remains today with added worry that funds moving out once
lower rates in India are juxtaposed with higher rates overseas.
Like RBI most central banks around the world are
looking at the Fed on when it will increase its rate and how they should shield
their economy with the appropriate adjustment in interest rates, the time has
come when the Fed must normalize interest rates or risk a collapse into crisis.
It has been nearly two years of
dithering since the Fed began to taper its bond purchase programme — a move
some thought would presage a swift tightening of policy. Hope had soared that
the September 16-17 FOMC meeting would bring an announcement of the first
interest rate rise since June 2006, although to say the time had come was
offensive to any casual market observer witnessing financial markets’ acute
vulnerability.
The truth is the time has probably come
and gone. But that should not have swayed Fed policymakers. The evidence is
abundant that the ability of monetary policy to spur economic growth is
exhausted.
More concerning are increasing
distortions in an economy and financial system that threaten to collapse into
crisis. The financial markets may not be fully on board with rising interest
rates, but any further kowtowing to investors’ promises to strip the Fed of its
last vestige of credibility. Financial stability has crept in as a de facto
third mandate, but the meaning has been perverted since former Fed chairman
Alan Greenspan first cut interest rates to prop up financial markets in 1987.
Stable has become a euphemism for buoyant as it pertains to risky assets, the
home of runaway inflation.
In the meantime Fed policy has
facilitated bad behavior. Corporate chieftains, a breed long plagued with
shortterm-itis, have been encouraged to trespass further by the siren call of
cheap money. Why bother investing in the long term when it is so much more fun,
to say nothing of more lucrative, to buy back shares, reduce share count and
puff up profits?
The build-up in capacity across a wide
swath of industries is also damaging. The corporate bond market has not
suffered a full default rate cycle in generations; such is the fear of
policymakers of allowing market forces to weed out the chaff from the viable
wheat. Is it any wonder capacity utilization has yet to recapture its 30-year
average of 79.5 per cent?
At least many companies have taken
advantage of this unprecedented era of low interest rates to extend the
maturity of debt on their balance sheets, insuring against potential damage the
next time capital markets seize up.
Many developed and developing countries
have similarly indemnified their nations’ balance sheets against another global
recession by issuing 50-year or 100-year bonds. If only the same could be said
of the US Treasury. Instead the US government continues to borrow short term —
as if the world were going to end tomorrow.
The Fed deludes itself with
manufactured inflation metrics that insult the average US household buckling
under the strain of untenable healthcare burdens, runaway housing costs and
steep higher-education expenses. Its other formal mandate, to maximize
employment, necessarily runs counter to maintaining price stability. Easy
monetary policy has been along for a nice ride back to a low rate of
unemployment but the numbers say so little. What does a 5.1 per cent
unemployment rate mean when the labor force participation rate is near a
40-year low?
Model-driven monetary policy that
constantly redefines itself by reducing the requisite unemployment rate and
ignoring rising inflation will not succeed. Meanwhile excesses continue to
build in the global financial system; pensioners and savers are more exposed
than ever to inappropriately risky investments. Normalize interest rates and
reinstate the incentive to save. Introduce a generation of millennials to the
sensation of earning interest. Might the interim be harsh, could be possibly.
But the alternative, lower for longer yet, is a price the country can
ill-afford to pay again.
Members of the FOMC call a press
conference at the conclusion of the October meeting and give the US a gift
that, in time, can keep giving. Own up to the fact that not taking action is
more harmful to the country and the world economy on the whole than finally
taking a stand and acting in its best interests.
_ Farzan Ghadially
