US interest rate dilemma

According to the mythology of capitalist economics, adjusting interest rates and the money supply can enable capitalist economies to negotiate their way successfully between maintaining full employment, ensuring a stable currency and controlling inflation. This is precisely the charter of the US Federal Reserve Bank, the US central bank. For the last seven years, the Fed has feverishly printed dollars, while keeping interest rates near zero, attempting to revive the US economy. Last December, with the US economy supposedly recovering, the Fed started talking about the need to ‘normalise’ monetary policy. Ever since, capitalist markets, companies and commentators have been asking: will they raise interest rates or won’t they? Now it finally seems likely that the Federal Open Market Committee will go ahead and raise rates at its meeting on 15-16 December 2015. Why should this tinkering with the capitalist economy be of any interest to us?

If monetary policy stays the same, then more bubbles, inflated with cheap money, will develop, eventually bursting, precipitating another recession or worse. However, if it changes, another set of risks increases. The Fed is damned if it raises rates and damned if it doesn’t. What has deterred the Fed from raising rates sooner is that inflation hasn’t yet reached the 2% target and unemployment hasn’t fallen to the target 4.9%. Reading the minutes of their October meeting, it is clear that those favouring rate increases are desperately scratching around for evidence that, even if the economy hasn’t hit the Fed’s targets, it is headed in that direction. There is also the fear, voiced in the meeting, that since the Fed has been threatening to jump for so long that if it doesn’t leap soon, people won’t believe it will and the Fed will lose credibility.

What has likely tipped the balance since October are statistics showing the US economy adding an unusually large number of jobs, and that ‘headline’ unemployment has fallen from 5.1% to 5.0%. This is interpreted as evidence of recovery. But when we look at the numbers closely, it is clear that if the US economy is recovering, then that recovery is faltering. The difference between 5.1% of the US labour force and 5.0% is 0.1%, or over 150,000 people. However the actual numbers show that unemployment has fallen by about 7,000 people, from 5.05% to 5.04%, respectively rounded up to 5.1% and down to 5.0%. Worse, when we include everyone wanting a full time job, the unemployment rate shoots up to 9.8%. With almost 10% of the labour force unemployed or underemployed, this is not a real recovery! Indeed the index of capacity utilisation has fallen from 78.5% in October 2014 to 77.5% a year later.

As with employment, so with inflation. The particular inflation index which the Fed officially uses has been dropping for the last few months. Worldwide, commodity prices have fallen, the Baltic Dry Index (a measure of shipping rates and the level of international trade) has fallen to a 30-year low. The prices of junk bonds (riskier high-yield bonds), with a high concentration of issues in the energy, mining and commodity sectors, have been falling. These point to deflationary, not inflationary pressures.

So, by its own criteria of employment and inflation, the Fed’s appraisal of the US economy appears stunningly optimistic, and certainly does not support the case for raising rates. What consequences may increased interest rates have?

Higher US interest rates will strengthen the dollar: it would require more pounds, euros or whatever currency to buy the same amount of dollars. Consequently, prices of US exports will rise and those of imports will fall, worsening the US international balance of payments and reducing production by exporters and production more generally.

The bond market, the buying and selling of government and corporate securities, is critical to capitalism: providing credit to governments, companies and banks and outstanding bond issuance in the US is currently $39.4 trillion. The Fed’s easy money policy has resulted in an enormous increase in borrowing by companies and the federal government. Outstanding corporate bonds have grown from $5.4 trillion in 2008 to currently $8.1 trillion, a massive 50%. Over the same period US government bonds have grown from $5.8 trillion to $12.7 trillion, an increase of 119%. Bonds pay a fixed interest, so when interest rates vary, so do their values – in the opposite direction. An increase in interest rates will reduce the price of bonds, leading to movements in the bond markets. However, market participants are complaining about a lack of liquidity, meaning it is difficult to match buyers and sellers. If bond market movements are disrupted by this, following interest rate rises, then this will lead to dislocation in mortgage lending, company borrowing and government financing with consequent interruptions in finance and production.

Internationally, a rate rise would spell trouble for the ‘emerging markets’ and least developed countries because they have loaded up on (currently) cheap dollar debt. Dollar debt outside the US has risen to $9.6 trillion; dollar loans to ‘emerging market’ countries have doubled to $3 trillion since 2008. About two-thirds of these loans are to corporations, not states. Roughly 80% of dollar debt in China is in short-term maturities – one year or less. The exchange rate movements consequent on a US interest rates rise would make these debts much more expensive to service and to repay. Much of the global financial system remains tied to US interest rates: according to the Bank for International Settlements, a 100 point move in US interest rates leads to a 43 point move for ‘emerging markets’ and the imperialist economies. A rise in US interest rates is therefore likely to give much of the world a severe shock.

Far from ‘normalising’ anything, the probable rise in US interest rates is likely to lead to instability and dislocation in markets and economies across the world, including the US. How typical that capitalism can only progress through anarchy and crisis!

Steve Palmer

Fight Racism! Fight Imperialism! 248 December 2015/January 2016


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