I’m fed up with loneliness, with my uncle overstressed. Fumbling, crawling for something that never shows, just a dream. I’m fed up with creeps crying over the past, such a sin. Not to be cool, but a fool, if I could mess up their rules. I’m fed up with your complaints, baby, well I’m not a saint! So goes the chorus to the song “J’en ai marre!” or I’m Fed Up by the 1993 song performed French singer, dancer and voice actress, Alizée, and written by Mylène Farmer.
The lyric about something that never shows, just a dream, really describes the American Fed, or Federal Reserve Bank Board of Governors, that orthodox economists seem to believe has magical powers over the economy. Eight times a year, this august group of bankers meet to supposedly set interest rate policy. And every time they meet, pundits, economists, and stockbrokers all wait the magic words from the wizards of the Fed to see if interest rates are going to rise or fall.
Funny thing is, the Federal Funds Rate, (also known as the Overnight Rate) is the only interest rate that the Federal Reserve actually sets. This is simply the rate at which banks lend their money deposited at the Federal Reserve to each other. In other words, the Fed does nothing to set market interest rates. The Fed does not set rates for mortgages, nor for business lines of credit, nor for credit cards, nor for anything else that actually impacts the economy.
One simply has to look at the data on interest rates (interestingly maintained by the Federal Reserve) to see that the Federal Funds Rate has absolutely no relationship with actual market interest rates. The Federal Funds Rate has gone up and down over the last 25 years and actual interest rates, well they have steadily fallen. Since 2009, the interest rate controlled by the Fed has been – well zero – while actual interest rates have fluctuated between roughly 2 and 4 percent. Overall, actual interest rates since the last recession have generally fallen and are now at historically low levels.Interest rates are not set magically by a group of seven wizards but by markets, and over the last couple of decades, market interest rates have been steadily falling. This reflects a number of things:
- Interest rates build in inflation, and generally speaking inflation has been falling over the past 20 years;
- Interest rates reflect the supply of money available to lend. This has been going up as wealth has concentrated into sovereign wealth funds, pension funds, and as the club of billionaires around the world has grown. Net savings after investment has grown by 538 percent based on data published by Brookings (https://www.brookings.edu/blog/ben-bernanke/2015/04/01/why-are-interest-rates-so-low-part-3-the-global-savings-glut/)
- Interest rates reflect the demand for loans. Interestingly it appears as if this has been growing dramatically, but debt statistics are likely not all that accurate. According to McKinsey, (http://www.mckinsey.com/global-themes/employment-and-growth/debt-and-not-much-deleveraging) global debt levels have grown by 129 percent since 2000.
The difference between the growth in savings and debt is important. Note that debt is up by about $112 Trillion, or about 6 times the entire GDP of the United States (in nominal terms). Even so, it has only grown slightly as a percent of GDP, and much of this debt went toward investment in productive assets.
Over the past couple of decades; however, the potential for productive investment has fallen as fewer businesses expand, and as governments shift resources from investment (roads, bridges, parks) to consumption (disability payments, SNAP benefits). This means that the increased savings is chasing fewer and fewer true investment opportunities. Rather it is being dumped into non-productive investments like expensive apartments in Manhattan, London and Miami, corporate share repurchases, or simply parked in safe deposit boxes in places with strange names like Andorra, Jersey Island and Grand Cayman.
All of this simply means that normal monetary policy, like interest rate signals from the Federal Reserve have become less useful as economic tools. This has led to what has been called “unconventional” moves by central banks to try to stoke inflation by simply printing money – euphemistically called Quantitative Easing (QE). However, with few opportunities to invest, the money created by QE efforts has not entered the economy, but rather sits in bank reserves held at the Federal Reserve. What has entered the economy has been shoveled into asset purchases, leading to increased values for non-productive investment like previously issues equities, gold and yet again, expensive apartments that nobody lives in.
Alizée was prophetic in 1993 when she sang fumbling, crawling for something that never shows, just a dream for it is just a dream, taken from an ancient theory from some long dead economist that central banks can control the economy. Markets will always outsmart central planners, and that is just what is happening to the Federal Reserve today.