May 25, 2016

Bait and Switch

If I could explain monetary policy using mainly actual English words, would you still rather slit your wrists than read it?

Tough one, huh. As you consider it, people everywhere are wondering if the Federal Reserve will lift interest rates in June. You’ve no doubt heard the chatter at the grocery store and in line at Starbucks.

No? Well, since the Fed looms over the stock market like a thunderhead on the plains, we better weigh it too. Whatever the Fed decides, it’ll be contradictory.

Here’s why. Suppose you got a credit card with a low introductory rate meant to encourage you to use it. You rack up bills at Nordstrom and Amazon. To thank you for doing as it hoped – spending – your card company raises the rate.  Now you’re paying a lot more interest.  So you spend less, to the dismay of Nordstrom and Amazon.

The Fed is the credit card company and you and your spending beneficiaries are the economy. But where the credit-card company wants future income via interest on your spending, the Fed hopes sustained teaser rates will drive permanent growth by causing businesses to hire people and make more stuff.  Ah, but teaser-rate spending is temporal.

The logical hard-drive crash gets worse. The Fed follows how much you make and spend. To track inflation, it meters the latter with what’s called “Personal Consumption Expenditures” (PCE). But PCE is also the largest part of how we measure economic growth. How can it be both?

Good question – and one I’ve not heard an economist ask a central banker. But it implies that much of GDP is just higher prices. Your money doesn’t go as far as it did.

Think about it. The Fed on one hand targets inflation around 2% (PCE is 1.6%), trying to create it with teaser-rate credit-card spending. But if it passes 2%, then the Fed wants to slow it down – and yet personal consumption is key to economic growth.

The credit card company must say when your teaser rate ends.  The Fed?  It’s kept everyone guessing, periodically yanking us this way or that, for seven years. Perhaps the reason the Fed is in a logical do-loop is because measuring consumption as both growth and inflation is an impossible balancing act.

Economic growth was 0.5% in the first quarter, and PCE is 1.6%.  If prices are rising faster than economic growth, isn’t that actually contraction?  Rising debt and rising prices are the enemies of prosperity because they diminish the capacity of consumers to buy things. Yet the Fed encourages rising debt and rising prices.

No wonder the stock market is consumed with arbitrage. And now, US consumers have as much debt as in 2007 but can afford it less because money doesn’t go as far.

What should the Fed do? Raising rates is baiting and switching. Not raising is robbing savers (and inflation steals from everyone). The Fed should not have offered a seven-year teaser rate without telling anyone. But the damage is done. Let’s stop.  Purchasing power is the engine of wealth, so we need monetary policy that preserves the value of money – the opposite of current programs. Let’s reverse course.

Hard? Yes. But it beats a do-loop of rising prices and rising debt.

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