Low Interest Rates A Weakening Tailwind To Our Economy

Low Interest Rates Have Failed To Produce Solid Growth

Sometime ago I wrote about lower interest rates being a "one-off" for the economy that was largely behind us. This has proven true across the world as the central banks have raced to the bottom only to find little relief from the slow economic growth that has haunted their economies for years. The truth is a policy of creating debt and stacking layer after layer of it behind the curtain has dampened the ability of consumers to move forward. The fact that even at super low-interest rates a great share of income must be diverted away to pay obligations created in the past leaves less money available for new purchases. This has a major dampening effect going forward. An argument could be made that the power of lowering interest rates is a one-off that has largely played out and ran its course.

If indeed the "one-time" economic tailwind is rapidly weakening and lost its kick as much of the recent economic data indicates, this has put both the central banks and the economy between a rock and a hard place. The big issue is where we go from here, regardless of what you name it the "Federal Reserve Nightmare" or the "Yellen conundrum", the box Ben Bernanke made when he painted both himself and the Federal Reserve in a corner remains. To make matters worse little has been done to address our structural problems and make America more competitive, this will massively thwart growth going forward. Adding to our woes is the Federal Reserve has failed to make any serious efforts in pushing the government to take the necessary reforms needed to move the economy forward.

Policy makers aided by the media thrive at presenting simplistic answers that solve both economic and society’s problems with little or no effort required from the masses. What former Fed Chairman Ben Bernanke started as a program to support and prop up the economy has over time morphed into the main driver of economic data. Between the low-interest rates that have propelled investors into high-risk assets in search of a positive return on their money, and money being pumped into the system, the markets have become distorted and disconnected from the economy. The idea that investors will continue to pour money into the sky high equity market is flawed.

With a policy of loose and cheap money and an inflation target of just 2% the Federal Reserve continues to please those gambling that not fighting the Fed guarantees profits. Even as many economist claim inflation is not an issue for the many Americans forced to pay higher food, rent, and health insurance premiums little comfort is forthcoming. It seems any thought that inflation is not higher has come from the false illusion brought from lower payments on things like auto loans and mortgages, this illusion will vanish if rates move upward.

Exports To America Key Support To Many Economies 

It must be noted that America imports around five hundred billion dollars more from other countries every year than they export. This means we have a giant trade deficit. When we add this to our enormous government deficit it is easy to see that we are living far beyond our means. It also means that America cannot afford to carry the weight of the whole world upon its shoulders much longer. The Fed has been superbly entrepreneurial when it comes to Ponzi schemes or pseudo-economics hocus-pocus that has allowed the current situation to develop. Even as many people have grown comfortable with the status quo this does not change the fact the Fed is in a difficult corner.

A serious exit strategy from QE  that normalizes interest rates remains elusive. With higher interest rates the cost of mortgages will rise. The low-interest rates that have discouraged savings and encouraged people to take high risks come at a cost and does not lead to a healthy economy, but rather a story that will end in tears and regrets. When interest rates rise, as they will at some point, the value of these risky investments will decline, and these investors will be hurt. Also, as a double whammy, interest payments on the public debt will rise, increasing the budget deficit, which has remained historically high and will be at the mercy of growing entitlement programs in coming years. Still logic dictates the Fed  must at some point begin to ponder a real exit strategy and end the massive and corrosive stimulus that the economy has come to expect.

If all the money dumped into the economy would suddenly change direction and rush into hard assets, the shift would be devastating to our struggling economy. This thought also raises other questions, what can we define as a hard asset, what is really available, and in what quantities? This may be where inflation raises its ugly head. An unknown and surprising fact about inflation is how fast it can take root. With such a shift, interest rates would move higher and investors would flee government bonds. The crash of the bond market and a popping of what many have called a Bond Bubble will become a reality. It is abundantly clear Janet Yellen has shown no interest in coming up with a plausible exit strategy and even after developing such a scheme making it work will be easier said than done.