Yesterday, the Federal Reserve announced that they would not be hiking rates. Expectations as to what the Fed would do flipped following the stock market crashes in China, which bled over to American markets. The drama in Greece and in the EU as a whole also shook the confidence that global markets would continue trending up and to the right.
The line that the press tends to promote is that a general improvement in conditions is what’s normal, and that crises are aberrant. In reality, history is mostly the tale of unending crises, shocks, unpredictable events, and radical political changes.
The reason that the Fed bureaucrats are too intimidated to raise rates is because the entire financial system has become dependent on low rates. While it might be technically feasible — and even better for member banks within the Federal Reserve system — to raise interest rates and thereby make it more profitable to lend money, doing so would risk generating a lot more political instability and trouble for corporations which have positioned themselves as to be totally reliant on cheap credit.
Hiking rates would have been better for the domestic commercial banking system — which is why the idea was floated in the first place, to make it appear like the system was more stable — but the crashes intimidated the planners away from attempting to get back to something resembling normalcy.
This political instability isn’t necessarily national in character — if the Chicago Teacher’s Union is so burdened by pension costs that it needs to shutter schools and cut expenses with a stock market juiced by zero rates, the situation would be much worse were the Fed to cut off the market’s air supply. If the Federal government can’t even agree on a budget and relies on central bank purchases of treasury bonds to avoid cash flow problems — in a zero-rate environment — then its ability to maintain the smooth functioning of the financial system is also in doubt.
Raising rates would also not necessarily ‘reduce’ inflation in the system, as implied by some of Janet Yelen’s speech in yesterday’s announcement, in which she said that the system would look to raise rates if the CPI increased to 2% per year. While higher rates might change some market dynamics, it would also create much more incentive within the commercial banking sector to increase lending — which would put more credit into the hands of ‘main street’ at the expense of the parts of the economy that find credit easy to access.
In history, what these kinds of schemes tend to lead to are an enormous expansion in some sectors of the economy at the expense of others. Borrowers (whether direct or indirect) benefit at the expense of creditors, who become expropriated. In the case of the ZIRP scheme enacted to bail out financial institutions, governments, and corporations, the system has expropriated some creditors to benefit some borrowers and other connected parties. When these schemes fail as they always do, the former heroes of the ‘new economy’ (really the beneficiaries of the bubble credit expansion) become villains virtually overnight.
Technological ‘revolutions’ go bust and are revealed to be unsustainable given the current environment. None of this type of pattern is essentially new, but we should expect it to repeat itself unrelentingly given the dire straits that world governments and the financial system finds itself in.