Update: On Wednesday, the Fed finally raised the federal funds rate a measly quarter of a percentage point after keeping it at near-zero since 2008. The market promptly reacted the next two business days, dropping the Dow Industrials over 600 points. If this continues, the Fed’s worst fears will come true; i.e., an increase in interest rates sends the market and a fragile economy into a tailspin. The fly on the wall knew all about this because he was there listening to Federal Reserve members grapple with the dilemma they placed themselves in. Sometimes it’s just better to punt. Instead, the Fed insisted on being always wrong, but never in doubt.
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Perhaps a fly on the wall at the last Federal Open Market Committee can help us understand how members of the committee arrived at their decision.
Here’s what the fly heard:
“Another meeting; another charade. How long can we punt this thing down the road? We are running out of excuses not to raise interest rates. It’s been over six years since we pushed the federal funds rate to near-zero. It was supposed to be a temporary measure. Within a year or so, the economy was supposed to rebound enough so that we could gradually return to a normal range of interest rates without fear of the economy lapsing back into a recession.”
“Those days are long gone. What worked in the past doesn’t work anymore. Our predecessors were asleep at the wheel and let the housing bubble get way out of hand. They knew full well that the housing market was over-heated and didn’t have the nerve to take away the punch bowl until it was too late. Why piss off our friends on Wall Street when everybody there was making money hand-over-fist peddling worthless mortgage-backed securities with bullshit AAA ratings to unsuspecting investors? Why piss off borrowers who could get interest-only mortgages with next-to-nothing down and without having to prove they were creditworthy or even had a job? To be a killjoy and stop the insanity would be poor form. It would also be a sure way of getting kicked off the Board and banned from a nice cushy job in the banking industry down the road.”
“So we wound up bailing out greedy bankers instead and then we bought up all their toxic Collaterized Debt Obligations at a premium. You would think they would show a little restraint — but no. They couldn’t wait to award themselves huge bonuses and strut around with shit-eating grins across their faces. No wonder Main Street Americans hate their guts and hate us, in turn, for doing the bankers’ bidding at every turn.”
“If zero interest rates weren’t enough to fill their coffers, we started those insane Quantitative Easing programs, which is printing money out of thin air by any other name. We were pushing on a noodle. It got us and the economy trapped in a quagmire. It also raised expectations that such bat-shit-crazy easing would continue in perpetuity. And those expectations have turned into outright demands that we continue more of the same.”
“Yeah. And where did all those low interest rates and QE schemes get us. They got us nowhere. In fact, they made matters worse because we boxed ourselves in. We pushed the stock market to the moon and made rich people richer. We pressed Joe Six-Pack to take on more risk in order to get a decent return on his investments. We punished savers, particularly seniors, like my mom and pop, by driving interest rates to nearly zero on the hard-earned money they have in their bank accounts.”
“And to what end? The economy is languishing, stuck in a lingering malaise. Real wages are flat or declining for most Americans, as their expenses continue to rise. People have dropped out the work force in droves; most have given up on ever finding a job again. Those who have jobs have seen their wages decrease because they are being forced to work fewer hours.”
“And we have the unmitigated balls to pretend everything is unicorns and rainbows. We have the gall to say we to intend to raise interest rates before the end of the year. Who the hell are we kidding? We know if we raise rates, it could crash the market in a heartbeat. If it doesn’t crash the market, it will certainly crash the economy. Then we will have to deal with the backlash and have to back down by lowering interest rates to zero once again, losing all credibility in the process.”
“We thought we could smooth the economic cycles, which have occurred from time immemorial. We thought we could eliminate downturns in the economy by cleverly manipulating monetary policy. We thought wrong. We found out the hard way that economic downturns are necessary to purge out excesses in our financial system. We fooled with Mother Nature and got burnt. Now we don’t know whether to shit or go blind.”
“With the media hanging on every single syllable that the Fed utters, we can’t even talk intelligently about the bind we’re in. Can you believe, we couldn’t purge the word “patient” from our FOMC reports without spooking the market? Hell, if we can’t even hint about raising rates without creating havoc in the markets, how will the market react if and when we actually raise rates? And, even if the market accepts that we will gradually raise rates, how will a weak economy react to such tightening? My guess is that it will not react well. The economy is too fragile for it to react otherwise. We are overdue for a recession and the next one will hit us real hard.”
“We’re so screwed. What the hell were we thinking?”
“We weren’t. That’s the problem. It sounded good at the time and we went with it. I can kick myself in the butt for being an imbecile.”
“That’s why we have to stay the course. Just keep moving the goalposts and keep interest rates where they are. An economic malaise is better than another Great Recession or, worse, a Depression. A rising or flat stock market is better than a collapsing market. When in doubt — punt. Or, should I say, keep punting. There will always be a reason for keeping interest rates right where they are now. Why tempt fate when you don’t have to.”
“But how will we ever normalize interest rates again? We are stuck at zero and we’ve been stuck there for a long time. If the economy falters and we enter a recession, we have nowhere to go. We can’t lower interest rates because they are already at zero.”
“You’re wrong. We can drive interest rates negative. Just like some of our European partners have already done. Why not?”
“I guess you’re right. That will get people off the dime. Why would they keep their money on the sidelines in their bank accounts and have to pay the banks interest for the privilege of holding their money? That should finally get the economy going because people will choose to spend their money and buy stuff instead of paying the banks to hold it. They sure aren’t going to put their money in the mattress.”
“Something tells me that Americans will not take kindly to negative interest rates. No way will that fly. (The fly’s antennae perked up at this expression but he didn’t let on.) At least, not in America. I think I prefer keeping rates at zero instead. In other words, I like keeping things exactly the way they are. Besides, doing nothing is the path of least resistance.”
“Didn’t we have the exact same conversation a few weeks ago and arrive at the same conclusion?”
“Yes we did. But practice makes perfect.”
“So, when the FOMC convenes tomorrow, we all know the drill.”
“Right.”
“Aw, come on! Let’s do something different this time and surprise everybody who says we don’t have the nerve to raise rates. It’s Christmas time and no one will pay much attention to a tiny quarter of a point increase. At the same time, we can regain some of the credibility we lost over the last decade. Besides, the economy is picking up steam and a quarter of a point increase in rates is more than justified.”
“Well, why not? The expectation of a rate increase this month is greater than it’s been in the last six years. If we disappoint the pundits again, the market might react negatively and we don’t want that to happen during the Christmas season. After all, our decisions are data dependent and the data says we should increase rates.”
“I see everyone approves. At last, rates are heading north. We should commend ourselves for a job well done.”
“Hear. Hear.”
The fly had heard enough. His head hurt. He flew away, wishing the occupants in the room would buzz off too.
– LV