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The Reason the Fed is Raising Rates, and Why It Won’t Work 

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Photo by DonkeyHotey | CC BY 2.0

Photo by DonkeyHotey | CC BY 2.0

 

Why is the Fed creating incentives for US corporations to destroy themselves? Why is the Fed pushing insurance companies and retirement funds into bankruptcy?  Why is the Fed raising interest rates when inflation is still well below its 2 percent target?

Things are not always what they seem. In theory, the Fed’s low interest rates are supposed to have a positive impact on the economy by spurring a credit expansion. But it hasn’t worked out that way. Bank lending has remained stubbornly subdued throughout the post-crisis period. But what hasn’t remained subdued is corporate borrowing (via the bond market) which has exceeded all previous records increasing the probability of massive corporate defaults sometime in the next two years. Here’s a good summary of what’s going on from an article in Fortune titled “Corporate America is Drowning in Debt”:

“A good portion of Corporate America may have a serious debt problem. According to a report released Friday from S&P Global Ratings, the bottom 99% of corporations, when it comes to the amount of cash they have, are increasingly showing worrying levels of debt.

Studying S&P’s universe of more than 2,000 nonfinancial corporations, S&P’s researchers found that corporate issuers of debt had on hand a record $1.84 trillion in cash. But that statistic doesn’t tell us very much about the health of individual companies, because it appears cash is more concentrated at the top than ever. The top 1% of corporate cash holders…have slightly more than half of the total cash pile of Corporate America….

If you remove the top 25 cash holders, you’ll find that for most of Corporate America, cash on hand is declining even as these companies rack up more and more debt at historic rates. The bottom 99% of corporate borrowers have just $900 billion in cash on hand to back up $6 trillion in debt. “This resulted in a cash-to-debt ratio of 12%—the lowest recorded over the past decade, including the years preceding the Great Recession,” the report reads.” …

One obvious reason for Corporate America’s debt binge is low interest rates. With investors willing to lend companies money for so little in return, it makes sense that firms would turn to debt to finance things like share repurchases rather than, for instance, bringing cash earned from overseas, which would then be taxed at a high rate.

….”Given the record levels of speculative-grade debt issuance in recent years,” the report reads, “we believe corporate default rates could increase over the next few years.” (“Corporate America Is Drowning in Debt“, Fortune)

Repeat: The vast majority of US corporations are worse off now than they were in “the years preceding the Great Recession.” And the reason they’re worse off now is because of  low interest rates. The Fed’s low rates create lethal incentives for CEO’s to pile on the debt which puts their companies at greater risk of default.  Corporations are borrowing tons of money from investors in the bond market, which they are distributing to their shareholders rather than using to improve productivity or increase employment. They are also recycling two-thirds of earnings into stock buybacks which is going to dramatically impact their future competitiveness.  Here’s a blurb from an article in USA Today that sums it all up:

“Capital spending fell 6.2% at an annual rate in the first quarter following a 2.1% drop late last year, its worst such stretch since 2009 and a big reason the economy nearly stalled in that period, Commerce Department data shows.

Business outlays were sluggish throughout 2015, rising 2.8% compared to an average 4.5% clip during the seven-year-old recovery. …Business spending typically makes up 12.5% of economic activity but has an outsized impact on the economy and stock market. Purchases of equipment and software, and the construction and renovation of buildings, create thousands of jobs for manufacturers. And such investment makes up nearly 30% of the sales of Standard & Poor’s 500 companies, says David Bianco, Deutsche Bank’s chief U.S. equity strategist….

Instead, public companies are plowing their large cash reserves into stock buybacks and dividends despite low borrowing costs.” (“Business investment is in a slump and its hurting the economy”, USA Today)

Stock buybacks– which were illegal before the Reagan administration — are a deceptive form of financial circlejerk that distort prices, create bubbles and lead to crisis. The reason the Fed ignores these issues because it sees profitmaking as a higher priority than ensuring the safety of the system. Go figure?

Since Donald Trump has been elected, the buyback frenzy has gained momentum mainly because he’s promised a one-time “repatriation holiday” for tax dodging US corporations who will be allowed to bring upwards of $1 trillion back to the US at a meager 10% corporate tax rate. Market analysts do not expect the money to go into production, hiring or infrastructure development, but into more buybacks that will send stocks higher into the stratosphere. Here’s the story from the WSJ:

“Corporate stock repurchases are on the upswing once again, wrong-footing skeptics who predicted 2016 would mark the beginning of the end of a postcrisis spending spree. Through Dec. 16, companies this month have stepped up their buybacks by nearly two-thirds over the same period last year, according to Goldman Sachs Group Inc….

The outlook for buybacks, like so much else in financial markets, has been upended by the Nov. 8 election of Donald Trump as president. After repurchases hit a record in 2015, they had slowed this year. Many analysts predict they will decline next year, reflecting soft corporate-earnings growth and stretched stock valuations. But the election surprise has raised the prospect that tax cuts will put large sums in corporate coffers, which in turn will be deployed largely in repurchases. That money potentially could include the profits that U.S. companies stand to bring back from overseas under a widely expected repatriation-tax holiday.

Goldman Sachs forecast that S&P 500 companies will repatriate $200 billion of their $1 trillion in cash held overseas in 2017 and that $150 billion of those funds will be spent on share repurchases. That could provide further support for major U.S. stock indexes that have hit fresh highs this month.”

(“Surging Buybacks Say Stock Boom Isn’t Over“, Wall Street Journal)

So according to G-Sax, 75% of all the dough returning from overseas is going go into buybacks that will pump up the equities bubble (that Trump criticized before he was elected) into the biggest colossus of all time.  Is that the change that Trump backers were hoping for?

Here’s more from the same article:

“Repurchases have been a major contributor to the nearly eight-year stock rally. From the start of 2009 to the end of September 2016, companies in the S&P 500 spent more than $3.24 trillion repurchasing shares, according to S&P Dow Jones Indices.

Both companies and investors often applaud share repurchases because the practice drives up earnings per share and often boosts stock prices.” (WSJ)

Ultimately, the buck stops with the Fed, that’s where the real blame lies. The Fed created the incentives for this destructive behavior and they are the primary regulator of the entire financial system. They could stop this nonsense with just one appearance before Congress, but they choose not to. They’d rather keep the real economy in a permanent coma and blow up the financial system than lift a finger to stop Wall Street’s reckless and relentless looting spree.

We know that the low rates have been disastrous for pension funds, insurance companies and Mom and Pop’s retirement savings which have shriveled to nothing since the recession ended in 2009. We also know that–during that same period– “97% of all GDP-income gains went to the wealthiest 1% households” which has widened inequality to levels not seen since the Gilded Age. The question is: Why would the Fed change its policy now that all the money is flowing exactly where the Fed wants it to flow, upwards?

Is the Fed really worried about inflation, is that it?

Not at all. All the talk about inflation is pure bunkum and the Fed knows it. According to the Wall Street Journal:

“The central bank’s preferred gauge of inflation, the personal-consumption expenditures price index, was up 1.4% in November from a year earlier, data showed Thursday. Another measure, the consumer-price index, was up 1.7% from a year earlier in November….

Fed Chairwoman Janet Yellen said this month that there are signs wage inflation is picking up. Yet the nonfarm jobs report this month showed average hourly earnings for private-sector workers declined 0.1% in November….

One other factor that may contain the risk of inflation is the U.S. dollar, which rose to a 14-year high against a basket of its main rivals earlier this week. A higher dollar reduces the cost of imported goods that may keep a lid on inflation, potentially delaying the Fed’s goal to push up inflation to its 2% target.” (“The Markets Say Inflation Is Coming. The Data Show It Isn’t True“, Wall Street Journal)

Get the picture? Even using the Fed’s own methodology (“preferred gauge”) inflation is still below the 2% target. It’s just not a problem nor will it be as long as the Fed keeps the economy in this Central Bank-induced Depression. Because during a depression, the demand for credit stays weak, and when the demand for credit stays weak, the price of money remains low. It’s just supply and demand.

So the question we should be asking ourselves is this: Is the economy still in the crapper or has activity really started to pick up like Fed Chairman Janet Yellen keeps saying? Here’s how the Wall Street Journal answers that question:

“Stock prices may have soared since the November election, but the U.S. economy is ending 2016 on an anemic note. Measures of economic vitality including income growth, consumer spending and inflation weakened last month following a short-lived spurt.

Household spending rose just 0.2% in November from the month before, a slowdown in growth from the previous two months, while incomes flatlined, the Commerce Department said Thursday. Inflation readings, which had perked up, didn’t budge last month, and demand for factory-made goods remained soft. For now, that leaves the U.S. economy in the middling trajectory that has marked the seven-year expansion.

“Underlying support for the consumer sector remains fragile at best,” said Lindsey Piegza, economist at Stifel Nicolaus & Co. “The reality the consumer is facing at this point is still modest wage gains and a continued loss of momentum in income growth.”

Forecasting firm Macroeconomic Advisers estimates the economy is growing at a 1.7% rate in the final three months of 2016. Federal Reserve policy makers expect the economy to grow 1.9% this year and 2.1% next year, a forecast the central bank has barely changed since the election of Donald Trump.

About two-thirds of total U.S. output goes toward domestic consumer spending. Solid household outlays during the summer helped propel economic growth to a 3.5% annual pace in the third quarter, the best quarterly increase in two years, according to revised data released Thursday. But income growth has softened: Wage and salary income rose 3.5% in November from a year earlier, the slowest year-over-year gain since December 2013.

Without stronger support from consumers and more investment by businesses, third-quarter growth momentum could wane.”  (“U.S. Economy Approaches Year’s End on Lackluster Note“, Wall Street Journal)

Yellen points to employment, consumer spending and “firming” inflation as signs that the recovery is strengthening, but as the article points out,  it’s all baloney. There’s no recovery.  Sure, there’s been a slight uptick in optimism because of Trump’s promise to spend a lot of money to fire up GDP, but most of those promises will never materialize, which means that growth will remain in the 2% doldrums for the foreseeable future.

But if the Fed is not raising rates to curb rising inflation or to prevent the economy from overheating, then what the heck is it doing?

Ahh, that’s where it gets interesting.

The Fed is raising rates because there is now widespread agreement that keeping rates low for a long period of time does serious damage to the financial infrastructure. That’s one reason, but it doesn’t fully explain what’s really going on. On a more practical level, the Fed is raising rates because of the banks. That’s right, it’s another handout to the big Wall Street behemoths. This is from the Wall Street Journal:

“Big U.S. banks have rallied in recent months amid rising interest rates but, if the Fed carries out its plans, there is room for them to keep rallying….

For American banks, a pie-in-the-sky scenario has just moved closer to reality. While struggling with ultralow interest rates, major banks have also been publishing regular updates on how well they would do if interest rates suddenly surged upward….Bank of America also says a 1-percentage-point rise in short-term rates would add $3.29 billion….a back-of-the-envelope calculation suggests an incremental $2.9 billion of extra pretax income in 2017, or 11.5% of the bank’s expected 2016 pretax profit…

With shares up 45% since the end of September, Bank of America is no longer cheap. But it isn’t expensive either… Especially if the Fed moves forward with more rate increases, there is room to go higher.” (“Banks’ Interest-Rate Dreams Coming True“, Wall Street Journal)

So higher rates and a steeper yield-curve mean heftier profits and higher stock prices, which is why the financials have been the hottest sector for the last six weeks.

Bottom line: The Fed’s rate hike has nothing to do with employment, growth, productivity, the state of the economy or inflation. It’s all about the banks.

And that’s why the plan is doomed from the get-go, because raising rates during a Depression doesn’t help to end the slump. It just makes matters worse.

More articles by:

MIKE WHITNEY lives in Washington state. He is a contributor to Hopeless: Barack Obama and the Politics of Illusion (AK Press). Hopeless is also available in a Kindle edition. He can be reached at fergiewhitney@msn.com.

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