The Economic Consequences Of The Rate Hike
The bald truth about the Fed's move to hike rates is that it makes no economic sense. Is inflation close to reaching escape velocity? Are we nearing a 1970s-style bout of crippling stagflation? The answer is no. Yearly inflation last month was 0.44 percent, substantially below the Fed's 2 percent yearly target. And core inflation was just 2.1 percent, almost exactly on target.
Then why would you want to hike rates in absence of an inflationary breakout? To stop job creation? ("Oh no! Somebody save us from all these jobs!") To get ahead of the very real and present danger that wages might rise?
The "sense" that the rate hike makes, as the Fed itself argues, is a kind of institutional sense. Rates must go up, because higher interest rates are what is normal. This appeal to normality, of course, is a well-known logical fallacy, and the Fed should really know better.
And why should we assume this is the case? As I've argued before, the dephysicalization of the economy may be pushing inflation substantially downward as our manufacturing and resource-extracting apparatus becomes more and more efficient and automated. This includes the cost of financial capital. Where once we had to dig financial capital out of the ground with many hours of hard, back-breaking labour, today we largely rely upon fiat financial capital produced at almost zero cost by banks. Around the world, lower inflation is becoming the norm. If this trend continues, deflation will become the norm, as prices trend closer and closer to falling costs of production.
As I argued last month, the only way under such a new system that financial capital can become more expensive on a sustained basis (i.e. for rates to go up, and stay up) is artificial scarcity. This month, the Fed telegraphed its intent to make capital artificially scarce.
Perhaps, as Marc Andreessen suggests, that is a side-effect of the Fed's policymakers having grown up in the shadow of stagflation. The Fed — perhaps like humans generally, although that is another topic for another day — is always fighting the last war, and for many of the Fed's policymakers (and other such habitual readers of The Wall Street Journal's editoral page) today's lowflationary grind is just another battle in the long war against stagflation.
I can't see this move as sustainable. The long-term trend is deflationary. Vehicles are getting more fuel efficient. Manufacturing processes are getting more efficient. Vast quantities of solar energy are coming online. America is producing so much fossil fuels it is able to export them for the first time in decades. Economies are becoming more and more automated. Capitalism as a system means an everlasting competitive race to economize, to drive down costs, and to get more for less. And since the 70s, as these processes and trends have moved along, interest rates have trended in one direction.
Mechanically, what a rate hike means is a disincentivization of economic activity, and an incentivization of sitting on savings and waiting for better opportunities. In the current context of relatively weakened economic growth and weak inflation, this incentive shift is likely to push prices closer to outright deflation, and the economy closer to recession. That does not make deflation or a recession a necessity in the near term, but it certainly — and in my view, unnecessarily — raises the prospect of these things. And it certainly lessens the prospect of rising inflation and rising growth, both of which I would see as positive developments as they would erode down the still dangerously levels of private debt as a percentage of GDP.
As Ryan Cooper argues, D.C.'s obsession with fiscal austerity has paved the pathway for mass discontent and the rise of proto-fascist populism, both in the U.S., as well as in Europe. After years-of elevated unemployment levels, weak-to-nonexistent Western middle class wage growth, and continued job migration toward lower-wage-cost East Asian manufacturing agglomerations, Western middle class frustration remains prominent even as the stock market and GDP have recovered and continue to hit record highs.
This new monetary austerity has the potential to continue this trend of middle class frustration and the rise of populists such as Trump who point the finger of blame at immigrants and other marginalized groups as simplistic explanations for complex global economic phenomena. Just as soon as the economy is getting toward a position where unemployment is low again, and thus stronger middle class wage gains become inevitable, the Fed decides to pull the rug out from under the recovery. Whoosh. In the name of what? In the name of some so-called normality?
Of course, that doesn't mean that the Fed is solely to blame if Ted Cruz or Donald Trump or some other nationalist populist becomes president in 2016. Indeed, it is not the Fed's mandate to worry about politics. Nor should it be.
Instead, the Fed should be worried about its mandate for 2 percent inflation, which it is not meeting, and which it is directly sabotaging with this foolish, mistimed rate hike.
Keep up to date with the latest thinking on some of the day's biggest issues and get instant access to our members-only features, such as the News Dashboard, Reading List, Bookshelf & Newsletter. It's completely free.