Outlandish as the question might sound, we do not even have to speculate too much. To a question from Reuters after the 17 September meeting of the US Fed, where they decided to keep the rate hike on hold, Chairperson Janet Yellen indicated the possibility of the above though she hastened to add that she did not think it likely. Not that I give too much credence to what central bankers say, but with their recent utterances the brazenness of policy options have reached a completely new level.
To start with, it was hardly surprising that Yellen decided to keep rates on hold. As I wrote a couple of weeks prior to the meeting (US Fed more likely to opt for QE4 than a rate hike), a rate hike was a very low probability event. Not only in the context of the September meeting, but looking ahead well into the future as well. I have written that Yellen is “likely to have her entire tenure at or near ZIRP” (zero interest rate policy).
It is not the usual suspects of unemployment or labour participation rate or inflation or the weakness of the global economy that is forcing the hand of the Fed. That said, it’s very likely that every one of those parameters will get worse “in real terms” over the next few months and years. All the additional liquidity being created by the Fed, the European Central Bank (ECB) and the Bank of Japan is just going to fuel even greater government deficits, gigantic bubbles in treasuries, malinvestment and speculation in the stock markets.
It’s this debt/leverage in the system that has tied the hands of the Fed: a national debt of nearly $19 trillion and unfunded liabilities of the US government that could be more than 10 times the national debt. There are other forms of debt - i.e. public, corporate, leverage in the futures/options markets, etc - that I am not counting. But even without these, we do have one nightmare of a burst ahead of us. This is the burst that Yellen is trying to postpone through ZIRP and quantitative easing (QE). But all bubbles eventually find a pin.
How in the hell did we reach such a calamitous situation? Through the Jugaad of central banking.
Raghuram Rajan, the Reserve Bank Governor, always interests me. He is perhaps the finest example of what Scott Fitzgerald described as a first-rate intelligence. “The test of a first-rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function”. So more often than not I tend to view his observations favourably - i.e. about free markets, getting away from jugaad and quick fixes, etc. But it just puzzles me as to how he misses the plain fact that he is operating the biggest jugaad in recorded human history - central banking.
Interest rates are the price of money. As in any other product/service, there are producers (savers) and consumers (borrowers) and all that we need is a market mechanism where the prices (interest rates) are set in such a fashion that demand equals supply. This is just economics 101. No different from the way in which the market sets the prices of land, cars and tomatoes.
Of course, governments need a central bank to monetise their deficits. But that’s very different from saying that markets need a central bank. Central banking is the key jugaad of governments that enables them to live way beyond their means. The sooner we can close down this institution, the better off almost everybody (exclusions would be the political class and crony capitalists) would be. But till Raghuram Rajan can resolve his cognitive dissonance or the “sheeple” can wake up, we can only hope.
And what next for the Fed? The only question that remains is “When QE4?”. Yellen might attempt a rate hike, but the markets could force her to reverse it in short order by panic selling in the bond markets. Since she probably knows this all too well, why even attempt the same and look foolhardy subsequently? She now has a new excuse in her quiver - the global markets - for postponing the hike.
On QE4, my guess is that we will see it before the end of this year. Much of the data that has come out in the US in the last few months has been pretty bad (same stores sales, inventory buildup, etc) and what better way to lighten up the Christmas season than QE4?
Shanmuganathan “Shan” Nagasundaram is the founding director of Benchmark Advisory Services – an economic consulting firm. He is also the India Economist for the World Money Analyst, a monthly publication of Mauldin Economics. He can be contacted at email@example.com
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Updated Date: Sep 21, 2015 16:18:31 IST