By Haddon Libby
Last week, the Federal Reserve’s announced that the Federal Funds rate was going to remain at essentially 0% – an emergency rate level that has been in place for six years. In deciding not to raise this key indicator rate to 0.25%, the Fed reasoned that the mix of subdued inflationary factors, a weak employment market due to historically low employment participation rates and offshore economic weakness gave the Fed no reason to act immediately. While three or four rate increases over the next fifteen months remain in their projections, the Fed is acting very cautiously on rate increases. Additionally, Janet Yellen, the Chairperson of the Fed, stated that they would remain very accommodative even after rate increases begin.
So what does this all mean?
In reading the tea leaves, pay attention to one Federal Reserve Governor who stated that negative interest rates remain a possibility. Negative interest rates? How could this be?
Think about the stock market fall last month. It was caused primarily by concerns about the Chinese economy. You see, leaders in that country are hell bent on keeping growth targets between 7.5% and 10% despite past excesses that are making that objective difficult to achieve. As a result, the Chinese devalued their currency. They did this to make Chinese goods more affordable around the world. This negatively impacts companies and countries reliant on sales to China as they will most likely see fewer sales in China as foreign goods are too expensive to the Chinese population relative to their domestic goods. This means that everyone will be selling less to the second largest economy in the world while we all buy more from China.
To better visualize this, think of China as a vacuum sucking up our dollars as well and those of workers around the world.
Thinking back over the last few years, part of what shook the US economy out of the Great Recession was a fiscal policy that weakened the US dollar relative to other currencies. This helped the sale of US goods to other countries which helped US companies get stronger and hire more US workers. Unfortunately, the new jobs paid less than the old jobs causing US workers to have less money. US workers represent two-thirds of all purchases in the United States. A weaker worker means a weaker economy.
Back to fiscal policy, other countries are wise to the currency devaluation approach now. As a result, there is a bit of a race to the bottom as it relates to currency values. This is done by printing more money and running government deficits. This reduction in currency value has the same effect on a domestic economy as an interest rate increase. You don’t see the cost in the interest rates that you pay but the things you buy like food. Think about that for a second in your life – food costs have gone up even though inflation has stayed low. Your dollar isn’t going as far although this has been offset somewhat by cheap Chinese goods which extend your purchasing power in the near-term but longer-term will weaken our economy.
Are you starting to see why rates did not move up? Increasing rates would hurt our economy and benefit a predatory Chinese economy. China is exporting not only goods but deflation.
I don’t want you to forget Yellen’s comment about employment. Obama touts a 5.1% unemployment rate as the lowest in a long time. While that is accurate from a statistical standpoint, only 62.6% of Americans of a working age are “participating” in the economy – the lowest level on record. These non-participants are people who have been unemployed over 15 weeks – the magical time period when an unemployed person is no longer counted. If we use the definition of unemployment in effect in 1970, true unemployment would be between 10% and 15%.
Haddon Libby is Managing Director of Winslow Drake, an investment management practice focused on individuals and 401(k) plans. He can be reached at hlibby@winslowdrake.com.
