The Fed's solo dissenter was right. Here's why ·CNBC
Dr. Michael Ivanovitch
Over the last month and a half, the Fed has increased the monetary base (M0, the only measure of money supply it directly controls) by $151.40 billion. That is a sharp reversal after $267.7 billion in liquidity withdrawals from M0's all-time record in October and its average balances in January.
Why did the Fed do this?
The answer was given by the Fed's policy-setting committee, the FOMC, last week. In a quasi unanimous decision (with only one dissenting vote), the Fed's governors claimed that a slowing tempo of a long-overdue interest rate adjustment was warranted by a less optimistic growth outlook, and by their more confident view of price stability this year and next.
Some veteran European monetary officials will have a chuckle while reading that the Fed was also concerned about the slowing economic activity, and rising financial instability, in the rest of the world. This new cosmopolitan policy bent will probably strike them as a departure from what they always perceived as America's lack of interest in foreign economic developments.
America's economy is OK
How plausible are these Fed's concerns?
Leaving aside the old chestnut of the "cautious pessimism," especially when markets are clamoring for more liquidity, let's take a quick look at (a) factors allegedly slowing the U.S. economy, (b) the claim of a benign inflation outlook, and (c) external economic events that could disrupt America's growth and employment.
Incomes, jobs and credit costs are the key drivers of the U.S. economy. At the moment, they all look good.
After-tax inflation-adjusted household incomes accelerated last year to an annual growth of 3.5 percent from 2.7 percent in 2014. And with a savings rate of 5.1 percent – one of the highest readings over the last 20 years – Americans now have some backup for the "rainy day."
The labor market situation has also improved considerably. More than 2.8 million new jobs were created in the year to February, bringing the unemployment rate over that period down to 4.9 percent from 5.5 percent. Labor market analysts would probably call this a full-employment unemployment rate, treating the 7.8 million people out of full-time jobs (involuntary part-time workers and persons dropping out of the labor force) as "frictional unemployment."
But whatever the qualifications, it is true that America's current jobs and income picture has rarely been better, including the booming 1990s.
Credit costs? The present 30-year fixed mortgage rate of 3.60 percent is 10 basis points below its year-earlier level, and well below the last year's average of 3.85 percent. Personal loan rates of 9.66 percent in the fourth quarter of 2015 (the last data point in Fed's most recent statistics) were also more than 100 basis points lower than at the same time in 2014.
These numbers don't show that American jobs, incomes and credit costs are the faltering underpinnings to demand and output in the months ahead.
How about inflation? Is the outlook so benign to present no risk to price stability this year and next?
Election year is a tough time
The core consumer price index (CPI) in February rose to 2.3 percent, the highest reading in nearly four years, and a significant pickup from a stable 1.9 percent rate in 2015. The core rate of inflation has been at the Fed's 2 percent medium-term target for more than a year.
Now, if you want to pick and choose you can ignore the CPI and look at the Fed's preferred inflation measure – the core personal consumption expenditure index. That inflation indicator hit 1.67 percent in a steady acceleration from 1.29 percent during the year to January.
And if you want to look at the unit labor costs – the true floor to any general inflation rate – you will see that they stood at 2.1 percent last year, roughly unchanged from a 2 percent rate in 2014.
Does that look like a benign inflation outlook? Maybe, if you assume that energy costs will keep going down at annual rates of 20 percent in the coming months. But how plausible is that?
Rounding off this quick review, what are we to make of Fed's concern about the rest of the world?
The main issue here is Europe, about one-fifth of the world economy, where demand and output are improving despite intractable political problems.
Germany is now spending big money to house, feed, clothe and provide public services to more than a million of its new residents from the Middle East. France is also stepping up its government outlays to accelerate the economic recovery and job creation in the run-up to May 2017 presidential elections.
Italy is cutting taxes. That is crucially important to revive the economy and keep the center-left government from losing ground. Berlin and its Brussels secretariat will have to stop opposing this fiscal stimulus at the time when four of the seven rightwing candidates for the mayor of Rome next June are running on fascist political platforms.
Bad economy and high unemployment are part of the reason why the electoral posters in the Eternal City are now showing admiration for Mussolini and his black shirts, and why a white obelisk honoring il Duce in front of the Stadio Olimpico seems to bother no one.
Spain has no government. The country is heading for new elections, but its fiscal policy and its informal economy (estimated at 25 percent of GDP) will remain broadly supportive of demand and output.
These four countries account for about three-quarters of the European economy, currently fueled by an ECB "whatever it takes" cheap and abundant liquidity to work in tandem with a more relaxed fiscal stance.
There is, therefore, no reason to worry about a negative impact of Fed's interest rate hikes on Europe. In fact, the Europeans would like that because they think that higher yields on dollar assets would push the euro down and give them another way out via exports.
Should we then worry about China?
That seems like an enduringly fashionable zeitgeist. But beyond that piece of entertainment, I don't see why we should think that the Chinese don't know what their problems are, and that they need our help to fix them.
That is absurd. China's track record of economic management shows that they know how to handle infinitely more difficult problems than the ones they are facing now. What they have at the moment is an embarrassment of riches, compared with lifting out of poverty and destitution 700 million people over the last four decades.
Investment thoughts
I suppose you can say that I am siding with that Fed governor who cast a dissenting vote last Wednesday.
I find that cutting the growth forecast for this year by two basis points is too specious an argument to justify a fairly strong resumption of monetary expansion, and an abrupt departure from an orderly and gradual policy adjustment. I also think that the current readings of Fed's inflation targets are far from benign.
So, why did the Fed decide to offer markets an attractive put?
The answer is simple. To paraphrase Jim Carville's famous slogan: It's the election year, …!
Imagine the disaster of lifeless or - God forbid – tanking equity values because the Fed failed to oblige. And imagine the godsend that would be for the Republican presidential candidate in a contest where everything hinges on the economy and financial markets.
Enjoy the ride. It's still too early to worry about the hangover. But (psst …) do add to your portfolios some of that yellow stuff before the word gets out.
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