Rate Hike Guessing Game Irrelevant To What's Really Ailing U.S. Economy

Since the 2008 collapse, the Fed has been buying government debt to keep interest rates low in hopes of inducing more spending by individuals and business. There are several reasons this approach is wrong:

• It eliminates the safe source of income for retirees;
• It inflates true value of assets;
• It does not address the underlying reasons for the languid labor market recovery.

These issues are covered below.

In 2007, the 10-year Treasury bond yield was 5%. Today, it is 1.7%. In 2007, many retirees were holding Treasuries: with 5% annual payments, and they were fixed for life. The Fed’s action wiped out this safe retirement strategy. Needing more than a 1.7% payment annually, retirees have been forced to purchase more risky assets.

I quote John Mauldin on the subject :

“I must confess, the more I think about where the “monetary policy community” of academic elites has brought us, the angrier I get…what the Fed has done is to destroy the retirement hopes and dreams of multiple tens of millions of my fellow US Boomers, and when we include the effects of the destructive policies of the rest of the world’s central banks, the number becomes hundreds of millions.… Remember when you could invest in a CD at 5% to 6%? What a quaint notion. By reducing the incomes of retirees and terrifying near-retirees, the Fed successfully reduced economic activity. Hopefully, that was not their intent, but that is what happened. Low interest rates have traumatized US pension funds and basically made it impossible for funds to meet their investment targets. And the consultants to whom the funds pay large fees are still showing them models (based on god knows what assumptions) that say it is okay to project 7% to 7.5% compound returns for the future.”

Enough said.

It would be one thing if the Fed’s low interest policy was getting individuals and firms to spend more. In all likelihood, it is not. In fact, in an overreaction to the 2008 collapse, it is very difficult to get a bank loan.”

Some argue the Fed’s low interest rate policies have resulted in increased borrowing to buy assets and this has led to artificially high asset prices. I am not taken by this argument inasmuch as I doubt the Fed’s policies have recently had any effect on spending. Yellen and others at the Fed have an inflated view of what impact they can have on the economy. The Fed’s tools to stimulate spending were exhausted some time ago.

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So what does the Fed see as the problem now? After all, the unemployment rate is at 5% and first-time unemployment claims are lower than they have been since 1973. Yellen recently said the question was whether that damage can be undone “by temporarily running a ‘high-pressure economy,’ with robust aggregate demand and a tight labor market….One can certainly identify plausible ways in which this might occur,” she said.

So Yellen is saying this is just a matter of increasing aggregate demand and thinks the Fed has some policy tools to help? I just don’t see it. Consider first how Americans are employed by sector. Table 1 provides data on 2015 employees and how the numbers have changed since 2000. Note the drop off in the goods producing sectors. And department store employees are also falling. Why these reductions? The information revolution. Labor saving automation in the factories of foods producers. But job cuts are also happening in the service sectors. For example, in retail trade, department store employment is down 24% as Internet purchases replace department store sales.