Forget Jerome Powell’s “pain” forecast and the stock market’s 1000-point drop. The significantly optimistic news is that the Federal Reserve Open Market Committee’s (FOMC’s) 12 members finally are throwing in the towel. No more will they drag out Ben Bernanke’s 13-year, failed attempt to boost growth by keeping interest rates abnormally low.
Why is that reason for optimism? Because allowing interest rates to be determined by the U.S. capital markets will release the currently untapped growth potential of U.S. capitalism. This accumulation of happy possibilities results from the FOMC’s misguided low rates that extravagantly rewarded borrowers and severely penalized savers and investors.
Importantly, Powell’s Friday (Aug. 26) remarks concluded with a firm commitment: “We will keep at it until we are confident the job is done.” That means we can count on short-term interest rates being allowed to rise to the level set by capital demand and supply. Such market-determined rates foster capitalism’s signature process of allocating capital to the highest beneficial (AKA growth) activities while providing a full market return potential to the capital providers.
Powell reveals an FOMC weakness
During his remarks, Fed Chair Powell surprisingly admitted that the FOMC members had learned three lessons – lessons that had been obvious during and following the 1965-1982 inflationary period:
- “The first lesson is that central banks can and should take responsibility for delivering low and stable inflation”
- “The second lesson is that the public’s expectations about future inflation can play an important role in setting the path of inflation over time”
- “That brings me to the third lesson, which is that we [the FOMC] must keep at it until the job is done”
While it’s good that the FOMC recognizes those three issues, it’s disheartening to learn that these Federal Reserve members had to learn them anew.
Powell’s “pain” prediction reveals serious misconceptions
Powell went on to predict pain from the Fed’s rate-raising actions. “While higher interest rates, slower growth, and softer labor market conditions will bring down inflation, they will also bring some pain to households and businesses.”
So many misconceptions:
- “Higher interest rates” – No. Moving away from FOMC-set (AKA, abnormal) low rates towards capital market-determined (AKA, normal) interest rates will open up growth opportunities, not reduce them
- “Slower growth” – No. Better allocation and improved financial income will foster more and healthier growth possibilities
- “Softer labor market conditions” – No. Heightened growth allows better allocation of human resources to improve both employer and employee strategies and productivity
- “Pain to households and businesses” – No. The “pain” will be focused on low-rate beneficiaries like highly leveraged companies, funds and individuals
Add to that list one more misconception: that the effects of the raising of interest rates in today’s abnormally low-rate environment are comparable to those of previous periods when the Federal Reserve raised interest rates higher than the capital market-determined level. Getting out of abnormally low rates and getting into abnormally high rates produce opposite results.
Think of the comparison this way. The current rate-raising is the result of the Fed easing off on its controls. Conversely, the raising of rates above the market-set rate is the result of the Fed applying controls.
What about Wall Street?
Wall Street will split and shift, as it always does when a trend is upended. The losers will be those tied to low-rate strategies. A return to normal interest rates harms their profitability and even their reason for being. Examples are over-leveraged private equity funds, real estate funds, hedge funds, and fixed-income funds. (Naturally, the managers of these funds are yelling the loudest about the Fed’s rising rates being a recipe for recession – meaning their own well-being.)
On the other side are the winners – the place where the rest of Wall Street will naturally gravitate.
The bottom line – Be optimistic because rates are rising
All-in-all, what’s coming will by exciting, dynamic and fun. There will be new growth areas that will prosper in the then-normal economic and financial period. Moreover, savers and “safe” investors will be welcomed back to the capital market table, able to partake fully of their rightful rewards.
In fact, that new “growth” segment will be all those individuals, organizations and governments that hold the $20+ trillions in short-term assets. After 13 years of lost income, they will earn full, equitable returns on their money. Besides income, they will gain a large “wealth effect” confidence boost.
How important is that segment? Very. The $20+ trillion is comparable to the annual U.S. GDP. Moreover, should the key 3-month U.S. Treasury Bill yield reach 5% (a reasonable historical and current environment level), the annual income could be about $1 trillion. Those are heady figures for a primary source of capital, especially when compared to the 20% loss of purchasing power it suffered during the Bernanke 13-year, 0% yield experiment.