On December 17, 2008, in response to the financial crisis, the FOMC (Federal Open Market Committee) lowered the Fed Funds rate to essentially zero. (The rate, which had been coming down for more than a year, had been 2% in September.) When Fed Funds were set at zero, the financial crisis, which had reached its perihelion in late September-early October, was already on the mend. The recession, which had begun in December 2007, was two-thirds past. Nevertheless, Fed Funds have been kept at this unprecedentedly low level for almost seven years. The Federal Reserve has become entrapped in its own snare, with no clear exit.
On September 16-17 the FOMC will meet. It had been expected that, finally, the process toward normalization would begin. (Historically, Fed Funds generally ranged between two and five percent.) Expectations had been that the rate would be raised by 25 basis points. But, with China’s economy and markets in free-fall, with our economy chugging along in second gear, with inflation seemingly tamed, and turmoil in equity and commodity markets over the past several weeks, there are doubts as to whether they will act. Eminent economists, like Larry Summers, have warned (incredulously) against the Fed being too hasty, citing the fragility of the recovery, as well as risks to speculative markets.
While August unemployment dipped to 5.1%, the lowest since April 2008, labor participation remains stuck at 62.6%, the lowest since October 1977. Most of the jobs added, as has been true for the past six years, were part-time. The unemployment number of 5.1% is based on the 157,065,000 people in the workforce – those working or actively looking for work. It does not include the 94,031,000 (the rest of the population above the age of 16) that are not counted as being in the labor force. Annual U.S. GDP growth, since the recovery began in June 2009, has averaged about 2%, the lowest of any recovery since the end of World War II. If the Federal Reserve wants an excuse from walking away from a rate increase, there is ammunition.
Cheap borrowing costs did attract more spending, but most all has come from the public sector. Both household and financial sectors deleveraged… or, at least, increased debt at slower paces. According to a study conducted by McKinsey Global Institute, global debt since 2007 has risen by $57 trillion (or almost 40%) to about $200 trillion. The main culprit has been an increase in public sector borrowings. Globally, government debt has risen at a compounded annual rate of 9.3%, while consumer debt has compounded at 2.8%. In the U.S., household debt is below where it was in mid 2008, while federal debt has doubled. That borrowing has done little to lift economic activity. In 2008, the year of the crisis and amidst a recession, the ratio of U.S. federal debt to GDP reached 70 percent. Today, with the Country in neither a financial crisis nor a recession, it is 100%.
Low interest rates have primarily benefited the federal government: they served to mask the actual size of the deficit. That increased deficit owes its existence to poor policy decisions by the Obama Administration, along with the failure by Congress and the President to implement meaningful regulatory and tax reform. In fact, both have worsened. Taxes have increased and regulations have stiffened. The crisis was cynically seen as an opportunity. In a February 9, 2009 interview with the Wall Street Journal, then White House Chief of Staff Rahm Emanuel opined: “You never let a serious crisis go to waste. And what I mean by that it’s an opportunity to do things you could not do before.” In other words, we were warned it was in the interest of the White House not to have the crisis resolved too quickly. And it has not been.
Instead of heeding the recommendations of the Simpson-Bowles Commission, a Commission set up by the President, an agenda was pursued that included a stimulus plan that Mr. Obama was forced to admit a year later “did not stimulate.” He unilaterally pushed through two significant programs designed to embed more deeply the role of government in our daily lives – ObamaCare and Dodd Frank. The consequence is that Mr. Obama has reigned over the slowest economic recovery in the post-War period. Additionally, wages have been stagnant, poverty has increased and income and wealth gaps have widened.
Over the years the Federal Reserve has played a critical role. In 1980, in raising rates rapidly, Chairman Paul Volcker induced a sharp recession, but he killed the dragon that was inflation. In 2008, working with the U.S. Treasury, the Fed played a vital role in avoiding a global, systemic financial meltdown. Left alone, it could have caused an economic Armageddon. The fact that that did not happen is testament to those in charge at the time – Timothy Geithner, President of the New York Federal Reserve; Ben Bernanke, Chairman of the Federal Reserve; Henry Paulson, Secretary of the Treasury, and President George W. Bush. While those four also bear some responsibility for the causes of the crisis, they were the ones who addressed it at the time.
Those were a dicey few weeks – the scariest of my more than four decades on Wall Street. However, as December arrived, so did a sense of relief. While stocks were still declining and the economy was still in recession, market observers noted that the TED spread (a measurement of perceived risk, determined by the difference between one-month LIBOR and one-month US Treasury’s) had declined from around 465 basis points in October to 131 basis points at the end of the year. Additionally, high-yield bonds had begun rallying in late November 2008. The worst of the crisis, in short, was over, but monetary policy has persisted as though it were not. Keep in mind as well, the BLS (Bureau of Labor Statistics) declared the recession over in June 2009.
The Obama Administration and the Fed (as well as Central Banks around the world) have created a Catch-22 – a conundrum with no easy answers. It will only be solved by a Fed Chairman – one with the intelligence, courage and the persuasive powers of a Paul Volcker. She (or he) will need the support of the President and Congress. The Catch-22 is a damned-if-you-do, damned-if-you-don’t situation. But we cannot go on as we have. Cheap money devalues currencies. It can destroy a nation. It can lead to another Armageddon. Central banks cannot be the only game in town. Legislatures and Executives must pick up the reins. The answers lie in normalized interest rates, tax reform that simplifies, lowers rates and addresses the need for individuals to save and invest for retirement, along with understandable and sensible regulation – lessening the grip of government, while giving more freedom to individuals and the private sector.