The Labor Department reported the economy added a disappointing 173,000 jobs in August. The unemployment rate fell to 5.1 percent largely because fewer Americans sought work.
Along with recent turbulence in financial markets and fears about the economic slowdown in Europe, this jobs report could delay Fed plans to raise interest rates. Sadly, prolonging low interest rates will do little to further boost the economy.
GDP grew at a 3.7 percent annual rate in the second quarter. The balance of this year and next, the pace is expected to moderate to 2.6 to 2.8 percent, but that is still considerably better than the first six years of the economic recovery.
Economists expect low interest rates to boost growth by encouraging consumers to purchase more big ticket items like new homes, appliances and automobiles, and businesses to finance new investments in plant and equipment. However, those sectors have largely recovered from the Great Recession and no longer need support from rock bottom rates.
The expansion of business investment remains weak by historical standards but that has a lot to do with structural shifts in the economy. For example, a single 3D printer can create prototypes and fill small batch orders for customers in many different industries. Replacing many machines with one lessens the need for larger capital outlays to support growth.
Business investment has shifted away from structures and machines toward more R&D and software design. The latter are inherently more speculative than adding a lathe or a drill press and are not as easily financed through bank loans. Instead, businesses rely more on cash flow to finance investments in knowhow and for many startups, the sweat equity and lean living circumstances of hungry entrepreneurs.
As economic growth becomes increasingly powered by the more efficient use of machinery and new ideas, low interest rates become a less potent tool for boosting business investment and stimulating the economy.
Inflation remains well below the Fed’s 2 percent target, but oil prices and other commodity prices are bottoming, and key Fed policymakers are confident that the pace of price increases will soon rise to levels necessary to support sustained economic growth. And this confidence was reflected in recent statements that indicate barring additional upheavals in financial markets, Fed policymakers are inclined to raise interest rates at their meeting September 16 and 17.
Keeping interest rates low for prolonged periods of time imposes distortions on the economy. For example, lower earnings on Certificates of Deposit forces many seniors to take part-time jobs to supplement Social Security—this displaces younger job applicants and suppresses wages.
Prolonged low mortgage rates push up land values in hot markets like Manhattan and the Silicon Valley to levels that may not be easily sustained when interest rates are normalized.
And low interest rates subsidize Wall Street private equity and activist investors—bent on quick payouts as opposed to positioning companies to innovate and grow—and that is attracting some of the best young talent to those non-productive pursuits.
Of course, low interest rates boost stock prices and fears abound that any move by the Fed will disrupt U.S. equity markets already made fragile by a slowing Chinese economy. However, it appears the recent correction in stock prices has already factored in a Fed move to gradually raise interest rates—perhaps a quarter point in the federal funds rate every other Fed meeting or about every 12 weeks.
The price to earnings ratio for the S&P 500 for trailing 12 month earnings is about 20.3—only a bit above its 25 year average of 19.2. And factoring in expected earnings growth over the next 12 months, the P-E ratio falls to less than 17.5.
A Fed interest rate increase won’t do much to harm growth, jobs creation or stock prices. We would get some additional turbulence in equities markets after the Fed announcement but within a few days stock prices should return to trend.
Longer term, stronger economic growth and adequate jobs creation should power up stock prices.
Peter Morici is an economist and business professor at the University of Maryland, and a national columnist. He tweets @pmorici1.