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Out-of-Touch Fed Is Hurting the Average American

Interest-Rates / US Interest Rates Oct 03, 2016 - 03:47 PM GMT

By: John_Mauldin

Interest-Rates

BY PATRICK WATSON : For the world’s top central banks, “the blind leading the blind” isn’t just a proverb. It’s reality.

A European Central Bank official recently said the ECB wants our Federal Reserve to hike interest rates in December. Why is that? In their twisted minds, it will confirm that years of monetary insanity actually worked.


ECB policy is far crazier than anything the Fed has done. We don’t have negative nominal interest rates, at least not yet. Ben Bernanke’s three rounds of quantitative easing were smaller (relative to GDP) than the ECB’s asset purchases.

But the ECB is on the wrong track whether the Fed raises rates or not.

The major flaw with central bank assumptions

Central bankers have a much bigger problem. Persistently low and sometimes negative rates are proving that their core assumptions about the economy are wrong.

For the last century, the standard response to economic weakness was simple: stimulate activity with lower interest rates. Make it less expensive for consumers and businesses to borrow money, and they’ll spend more freely and the economy will grow.

That’s the theory.

But here's the fatal flaw: Low interest rates motivate people to borrow money only when they are confident they can pay it back.

With banks blowing up in 2008–2009, home prices cratered and companies laid off workers. And very few of us felt that kind of confidence.

Those memories still persist. Just look at the Great Depression of the 1930s. Those who lived through that time remained cautious their whole lives. Our generation has learned the same hard lesson.

It gets worse.

The near-zero and now below-zero rates did inspire borrowing… by the very wealthy. People who didn’t need free cash took it anyway. Then they used it to bid up asset prices and create the current real estate and stock market bubbles. QE blew those bubbles even bigger.

At the same time, retirees living off their savings responded to zero yields, not by spending more, but by spending less and saving more.

As recently as late 2007, anyone could make a 5% or more, no-risk return in plain vanilla bank accounts or Treasury bills. Central banks intentionally killed that opportunity and still haven’t restored it. I doubt they ever will. In fact, they just had a chance to do it and didn’t.

The longer the Fed waits to hike rates, the more radical its response will be when the next recession comes. This is why I think we will see negative interest rates and cash controls here in the US. The only question is when.

The Fed is out of touch with real life

You might wonder why the Fed and other central banks don’t see the folly of their ways.

I think it’s because they look inward. They get their advice from academic economists who live in ivory towers. They don’t know what real life is like for average people.

So, how can we make them understand?

Here’s a simple idea that Congress could pass tomorrow: Require all Federal Reserve governors to spend two weeks a year working in some kind of blue-collar job.

They can be Wal-Mart cashiers, airport skycaps, taxi or Uber drivers. They can sling fries at McDonald’s. The point is to show them what economic reality looks like for the people they supposedly serve.

Do this and the Fed’s leadership will learn what average Americans—and yes, even older, working Americans like themselves (Yellen is 70, vice chair Stanley Fischer is 72)—must do to make ends meet.

I feel confident the experience would improve Fed policy and help the economy. And if not?

It will at least deliver a little bit of justice.

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