Well, this is the big day.
The FOMC — the group within the Fed that votes on policy — is supposed to make a historic announcement.
It is supposed to begin going ‘back to normal’ with interest rates.
Late at night, after hours of drinking, meditation, and prayer, we decided to get the inside scoop.
Here’s how it went…
Weight of the world
‘Yo… Janet. This is Bill.’
‘Excuse me…How did you get this number?’
‘I asked the NSA. It has everyone’s number.’
‘I’m sorry…but I have to hang up. I have a big day tomorrow.’
‘Yes…that’s what I wanted to talk to you about. I sympathise with you completely.’
‘You must feel the weight of the world on your shoulders. Your decisions will affect the entire planet’s economy. Speculators will get rich…or lose their shirts. Businesses will flourish…or go broke. Jobs will be gained…or lost. Lives will be affected…some of them in devastating ways.’
‘We are just doing our job.’
‘Yes…And no matter what you do…some people will complain. If there is a bear market or a recession…they will blame you. It isn’t fair, is it?’
‘Well…we do our best.’
‘Yes…and who could deny that you’ve done a magnificent job? Your interest rate policies have helped bring about a recovery. We owe it to you. If you had let the market set interest rates, it would have been a disaster. Instead, you knew better…As Ben Bernanke put it, you had the ‘courage to act.’ And it paid off.’
‘I’m afraid I will have to go…’
‘But…your rate policy has been so successful, I can’t help but wonder: why stop now? I mean, you’ve demonstrated that you can choose a better rate than the market; why would you want to go back to…’
‘Remember, this was an emergency policy. It was never meant to be permanent. Ultra-low rates have helped bring a recovery. But they may cause distortions.’
‘So…That’s why you need to go back to ‘normal,’ right?
After an awkward pause, the conversation continues…
‘But doesn’t a normal economy have setbacks? Aren’t recessions normal? Aren’t bear markets normal? And aren’t those the very things you were trying to avoid?’
‘Well, we adapt our policies to the incoming data…’
‘That’s what I mean. What if the data turn negative, sour, or uncomfortable?’
‘We believe the recovery is sufficiently established so that it can support a higher interest-rate environment.’
‘Hmmm….This zero-rate environment has been in place so long. We read in the news tonight that there are many people on Wall Street who have never seen an interest-rate hike. There is a generation of investors who have never seen a bear market in bonds. And there are two generations of investors who have never seen a real credit contraction.
‘Just wondering,’ we pressed on, ‘but McKinsey came out with an interesting white paper recently. It reports that there is now $57 trillion more debt in the world today than there was in 2008. This has raised the ratio of global debt to GDP by 17 percentage points — quite a step up!
‘And all of this arose, developed, evolved in very special conditions…with money available at near-zero rates. There’s student debt, auto debt, corporate debt, sovereign debt — and all of it now depends on this environment to survive.’
‘Yes, there are bound to be some adjustments as we approach our policy goals of maximum employment and price stability. But we will keep a close eye on our dashboard of indicators and take appropriate action, as necessary.’
‘But what action can you take? All you can do is to turn around. Like the Japanese. The Israelis. And the Swedes. All tried to return to normal with their interest rates. And all were forced to go back to rate cutting as their economies weakened.’
‘What did you say your name was…?’
‘Just call me Bill…’ (We were worried she was having our call traced.)
‘Well, Bill, yesterday, the Dow rose 157 points. A nearly 1% gain. Investors have confidence in us. We’ve proven that we have the experience and the expertise to manage the economy even in difficult circumstances.’
‘You’ve only proven that when the going gets rough, you can cut the cost of credit. But, as you say, that produces distortions. And the obvious distortion is $57 trillion in new debt — not to mention the governments, businesses, and households it financed — that may only be able to survive in your abnormal interest-rate environment.
‘Now, you say you’re aiming for normalcy. But I’m wondering what you’re going to do when the climate changes. Like those dinosaurs that evolved in the tropical heat. Then, when a meteor hit the Earth, the climate suddenly changed. And the big lizards were dead meat.
‘What would happen if the interest-rate climate went back to normal? You’d get a recession. Or a crash on Wall Street. Or a depression. What will you do? Tuck in your chin, stay the course, and bear it? I don’t think so.’
‘Our policy choices will be data dependent, as always.’
‘But that’s just it… If you’re reacting to data, you can only react in one way. Sooner or later, the data are going to turn sour. You’re not going to speed up the tightening cycle in the face of worrisome data, so that leaves only two choices. If you ignore it, then you are not ‘data dependent’ at all; you are data indifferent. If you don’t ignore it, you’re going back to an abnormal interest-rate environment.
‘In other words, you are trapped, aren’t you? If you ignore the data, you must suffer the outrageous fortune you’ve worked so hard to avoid for the last eight years. Only worse, because you distorted the critical price signals of the credit market, which has led to the build-up of trillions more dollars of subprime, unsustainable debt.
‘But if you react to the data,’ now we were getting revved up… and looking out the window for police lights, ‘whether it is a bear market or a recession — both of which are inevitable…and both of which are overdue — you signal to the world that you don’t really know what you’re doing.
‘You don’t know what interest rate is best for the economy, after all. You’re just making it up as you go along…reacting to the news in the old-fashioned way…with more easy money — just like every other wayward central banker in history, from John Law to Gideon Gono…
‘Janet, I’m so sorry for you. You seem like a nice person. How did you get yourself involved in this mess?’
‘Thank you so much for your sympathy…Now, I must hang up.’
‘Ok, Janet. Sleep tight.’
For Markets and Money, Australia