MONEY 85 - FEDERAL RESERVE

THIS IS MY 85^TH BLOG ON UNDERSTANDING MONEY TOOLS

This past Wednesday, December 16^th, 2015, the Federal Reserve Bank raised the interest rates 25 basis points (1/4 of 1%).  Let’s have some fun discussing the Federal Reserve with some basic understanding.  The Feds have not raised interest rates in almost a decade, last time being in June, 2006. We’ve been in an economic downturn (recession), a banking collapse (2007-2010) and then, I love the word spun these days, “tepid” growth ever since.

Who is Chairman of the Federal Reserve Bank?  Janet Yellen. The person heading up the Federal Reserve is always referred to as Chairman whether a woman or man. Please forgive me if some of this information is repetitive of prior blogs, but I am getting older and can’t remember what exactly I wrote in the past.

I realize I’ve covered this before.  The Federal Reserve Bank has 12 regional districts in the US.  The “Fed” acts similar to world Central Banks for other countries. The Fed is a depository for money, non-profit, money is borrowed inexpensively, it transfers money to the US Treasury as needed, provides liquidity, buys and sells securities (bonds), and attempts to balance financial markets, thus hopefully avoiding financial disruptions including recessions and high inflation.

Is this need for a bank new in this country, no.  After the Revolutionary War  we were starting a new country with a new currency; we had banking needs and discussed a “central bank” concept.  Every war ends with costs/debt that puts a country in dire straights. The Revolutionary War no exception, and every war since.  The Federal Reserve Act was passed when President Wilson was in office on December 23, 1913.

Let’s look at the possible reasoning the Feds raised interest rates (besides throwing darts at a target, or perhaps a ouija board).

-       The Feds say the economy is “robust”. One of the longest periods of growth, however there is almost no growth to speak of being below 2%, and that is not ideal. If we look at growth cycles and recession cycles we are ready for a recession. If the Fed raises interest rates quarterly in 2016, they can lower rates in the future to help the economy; supposedly.  ( Low interest rates haven’t helped over the past 7 years so why now? Our good economy from the oil and gas business in Texas and North Dakota is now “bust”.  75% of rigs are idle and unemployment sky high in that industry. That is why the government is not including farming and oil/gas in their new economic numbers.)

-       Concerns about high inflation down the road. Reality check: to have inflation in a country there needs to be more money (M1) which there has been to the tune of about $4.5 trillion.  Then, there needs to be availability of money to the masses of people, which there hasn’t been. Then, money needs to circulate “V”, standing for velocity, and there hasn’t been any. Money needs to circulate through a society one to six times a year, each time it is taxed for goods and services by the US Gov’t, State Gov’t, County Gov’t and finally City Gov’t. The dollars also need to remain within the country not be given to other countries and used on wars outside the US.

-       Even though the Feds sold $21 billion in bonds in October at zero      interest rate yield showing the perception of US strength, if the US weakens or if there is an alternative strong currency to the US Dollar we may not be able to sell bonds at low rates. The Feds would like to sell off up to $2 trillion in bonds over the next couple of years and get that amount off the balance sheet. Up until the need for the Treasury to print huge amounts of money in 2008 (Quantitative Easing) the Fed never had such exposure to debt as they do today.

-       A token higher interest rate should help older people on fixed incomes in the hopes that banks will pay something better on savings accounts and certificates of deposit.

-       Unemployment dropped to 5%, close to “full employment”. (Truth of the matter is that there are now over 94 million worker age people, many desiring work, but no jobs except the lowest paying, thus a total of 144 million Americans on some sort of government benefits. Average worker week dropped from about 34.7 hours to about 34 hours, meaning new job reports reflected part time, low wage jobs and employers avoiding paying benefits and pensions.)

What are some of the negative issues with the rise in interest rates?

-       It will strengthen the already strong US dollar.

-       A stronger dollar will make exports more expensive and less attractive. Our trade imbalance with foreign countries will increase especially with the new Pacific Trade Agreement.

-       Companies will need to pay more for everything, thus cut back on spending and improving equipment such as computers and machinery. With less spending inflation will be brought down to nothing and perhaps go negative.

-       More likely the rise in rates will precipitate a recession.

-       Less employment, not more.

-       Emerging countries borrowed money with bonds getting paid mostly in US dollars, thus they will need to pay back more money as their currency has weakened.  This eventually will make them less likely to be able to pay their debts permitting large companies and the wealthy to “cherry pick” their assets.

-       The US debt will increase. Newly issued bonds and sold will carry higher interest rates.  Current interest on our debt is about $500 billion/year.  The newly passed budget doesn’t reflect anything toward interest payments. The US debt is reaching $19 trillion, and when future US obligations are placed on top the total comes to around $100 trillion. No way out except if you are a magician.  The other options are ugly, default on bonds, restructure debt, or keep printing more money eventually being very inflationary.  Raising taxes only diminishes growth, GDP.

Higher interest rates will affect you and me in these areas:

-       Adjustable Rate Mortgages “ARMS” will go up.

-       Auto loans will be more expensive.

-       Credit card interest will go up.

-       Financing computers and office equipment will go up.  All short term financing!

Long term mortgages (30 year mortgages) and debt have already built the rise in interest rates in quotes.

There is a big liquidity bubble happening. Private equity money is diminishing, and that includes private venture capital for new companies. The “big boys” are getting very concerned. In countries around the world including the USA both private and public debt has reached phenomenal highs, this being measured as debt to Gross Domestic Product.  The highest being in Japan right now.

Let’s hit upon a couple more things while on this blog. Economically we can’t get our rears in gear. There are some reasons obvious to me.

-       Much of the world is in recession, why should we be an exception when we are in a world economy?

-       We killed a couple of the most purposeful Acts in our history in my eyes, these being the 1894 Sherman Anti-trust Act to prevent the “big boys” meaning the wealthy and large corporations from killing middle class small companies and consolidating, and the very important Glass Steagall Act of 1933. The Glass Steagall separated financial industries to keep specialization in and collusion out.

-       Paul Voelker meant well as Fed Chairman under President Carter and controlling hyper-inflation brought on mainly from oil pricing in the late 1970’s (for those of you who remember 20% interest rates). Voelker re-entered the scene after the banking crisis of 2007 and helped design and pass the Dodd-Frank Wall Street Reform and Consumer Act of December, 2013.  (Wow, exactly 100 years after the passing of the Federal Reserve Act.) The Act meant well but has impeded growth and logical bank lending. It was written to prevent banks from speculative loans, and proprietary investing by Wall Street Banks. What happened, tons of paper work, the need to document everything, banks deciding not to loan at all, and the shrewd managers with the Wall Street firms leaving and forming hedge funds which are not controlled by banking laws….reminds me of the great movie, “Dumb and Dumber”!

Here is an example of bonds gone bad/a country needing money/banks not lending. I am sure you have heard that Puerto Rico couldn’t make payment on bonds. They are now going to hedge funds in NYC and elsewhere and these hedge funds want 20% interest. Like sharks whether it is Puerto Rico, Greece or someplace else, there is always money to rape and pillage!

Viva the Federal Reserve, hope they made the right decision raising rates!