When central banks manipulate interest rates, they disrupt normal patterns of savings and investment. They pump up economic bubbles that ultimately pop and kick off economic crashes. We saw this vividly in the 2008 financial crisis. Low interest rates, along with government policies, encouraged unsustainable investment in housing. When the bubble popped, it nearly brought the entire economy down with it.
There is another problem with central bank interest rate tinkering that exacerbates bubbles.
It hides inherent risk.
We recently reported that bankers around the world have started to express concern about the rapidly inflating stock market bubble, and its future impact on the world economy. While many in the mainstream banking world agree the problem exists, they see different causes and call for different solutions. Some worry the Fed might raise rates and end expansionary policies too quickly. Some fear the central bankers may not do it fast enough. These contrasting concerns reveal the tight spot the Fed finds itself in. Yellen has put herself between a rock and a hard place. If she tightens, she risks bursting the bubbles. If she doesn’t, she risks inflating bubbles further, leading to an even bigger crash when they finally burst.
The following article by Thorsten Polleit was originally published by the Mises Institute Fed Watch. It offers some in-depth analysis on the options the Fed faces along with a gloomy conclusion. No matter what, it will remain on a course to trouble.
Federal Reserve chair Janet Yellen spoke to Congress yesterday. She talked. But she didn’t say a whole lot.
Most analysts seemed to view Yellen’s speech as “more dovish.” She expressed concerned that inflation my not be rising fast enough to meet the mythical 2% target, and that could slow the pace of rate hikes.
It’s premature to reach the judgment that we’re not on the path to 2% inflation over the next couple of years. We’re watching this very closely and stand ready to adjust our policy if it appears the inflation undershoot will be persistent.”
In his most recent podcast, Peter Schiff made the case that the current environment of rising interest rates is actually bullish for gold.
The most recent jobs report had most of the mainstream giddy with optimism. As the New York Times put it, employers added an “impressive” 222,000 jobs in June, according to the new government report released Friday. The unemployment rate ticked up slightly to 4.4%, but analysts say that was that was due to some people who had dropped out of the labor force coming back.
With rosy jobs numbers to bolster the Federal Reserve’s confidence in the direction of the economy, most analysts became even more convinced the central bank will push aggressively forward with its interest rate normalization program. As a result, many people have turned very bearish on gold. Peter Schiff took on this notion that rising interest rates are necessarily bad for gold in his most recent podcast.
The June Federal Reserve rate hike wasn’t a surprise. Most analysts expected Yellen and company to boost rates by 0.25 points. The only thing that was a little surprising was the hawkish tone the central bankers took at the most recent Federal Open Market Committee meeting. The Fed is hinting it will continue to push forward with interest rate normalization and begin to shrink its balance sheet. This raises an important question.
As we have pointed out, the data simply doesn’t support the hawkish stance taken by the Fed. Even some mainstream analysts have made this observation. So what gives? Why is the Federal Reserve so desperate to hike rates?
As we pointed out last week, the Federal Reserve finds itself stuck between a rock and a hard place. Well, data released last Friday made that squeeze even tighter.
Weak employment and wages have many analysts backing off expectations for aggressive action by the Federal Reserve this year. The Fed has been talking up the economy for months to justify interest rate normalization. But the actual data tells a different story. As Peter Schiff put it in his newest podcast, the most recent weak data further undermines the Fed’s credibility.
The Federal Reserve basically has two paths forward.
It can continue raising interest rates and risk popping the stock market bubble (among other balloons) it has inflated over the last 9 years. Or it can hold rates at the current artificially low rates and risk a currency crisis.
That’s it. That’s the corner the Fed and other world central banks have backed themselves into. They’re stuck between a rock and a hard place.