The Price of Money

“It’s a lock” is the consensus on Wall Street, referring to the Federal Reserve raising interest rates for the first time in a decade in their upcoming December meeting. But in fact, it is not a lock, the Fed will continue to kick the can down the road and just like in 1999 and 2007, the consensus is wrong, blinded by the exuberance of years monetary interventionism.

“Who cares, anyway?” you might ask. Why do interest rates even matter? The central bank’s interest rate matters greatly. It is this rate that ultimately determines the base for all interest rates of all debt in the economy. Low rates encourage borrowing while high rates discourage it. Of course, that is a simplification, but the general effect of the central bank’s interest rates is not contentious. They are essentially setting the price of money.

Before central banks usurped the power to control the price of money, the free market set the rate of interest based on the availability of capital in hundreds of independent banks. Yes, there were bank runs and panics, but that messy and imperfect system was far stronger than the systemically flawed system we have now. The disaster that is baked into this cake will show that we have converted small distributed risk and failure into a giant centralised catastrophe.

So the central bank price fixes the rate of interest. What carefully deliberated number do you suppose the economy needs? What balance between creditors and debtors should be reached? Zero. Zero is the rate we have had for the last 8 years. Zero is the rate that minimises the burden for debtors. Zero is the most politically expedient number that can fuel the rampant speculation that replaces genuine economic growth. That rampant speculation keeps incumbents in power as it masquerades as a genuine economic recovery.

“So will they move in December?”. With the stock market near record highs, and the unemployment rate hitting a new low for the move, it seems like it might be the right time to start normalising rates and reloading the monetary policy ammunition. However, unless the Fed is completely clueless and not just dishonest, it knows it cannot raise interest rates. The whole expansion since 2008, fueled by zero rates depends on those rates staying zero. As soon as the first quarter-point rise comes in, and with the anticipation of full normalisation, the bad news will start coming in fast. The stock market, auto loans, student loans, the mortgage market, oil loans and credit card debt are now extremely sensitive to interest rates.

But in reality there is one main reason that the Fed is stuck. Actually, make that eighteen trillion reasons on a very short maturity. Low interest rates help debtors, and the biggest debtor in the history of the world cannot afford a rate higher than zero. Janet, though nominally independent, knows which side of her bread is buttered. If Barack is going to successfully hand over the baton to Hillary, there will be no rate hike this year, or next. They will talk about it though, a lot.

Although the Fed will never want to raise interest rates, ultimately it will have to. When the market wakes up to this charade, the realisation will be that the Dollar is not the cleanest shirt in the hamper. Once it starts on its road down, the only thing that will stop the Dollar’s free-fall will be Fed action. Once that action comes, there will be a lot of pain as the debt-fueled speculation will have to unwind. Ultimately, zero rates will lead to zero confidence in the currency and the Fed will have spoil the party. Either that, or the Fed sticks to its guns and it’s back to barter.

Winter is coming