For the last two years I have listened to the boisterous commentary from scholars, business professionals, journalists and politicians about when and why the U.S. Central Bank will or should raise interest rates. Most of it has been thoughtful and pragmatic; some of it not so much - but I had to laugh when I saw Donald Trump's comment that Janet Yellen is intentionally keeping short-term rates low to benefit the Obama administration. It makes me wonder whether he understands the global economic dynamic in which we operate. Donald Trump, the self-proclaimed master of the real estate universe and our global economy should, of all people, get it. After all, he has benefitted from it. As a fellow real estate professional, I feel compelled to give more depth on this subject so that the electorate can better analyze these assertions. The truth is far more complex than Trump suggests.
It is important to distinguish between short-term interest rates and long-term interest rates. Short-term rates that can be affected by our Federal Reserve include the Federal Funds Rate, which is the rate that one bank charges to lend reserves to another bank, and the Discount Rate, which is the rate that banks pay when they borrow money from the Fed. In theory, how the Fed manages these rates can have wide implications for our economy, and generally affect the supply and cost of money. Less expensive money generally promotes growth, while more expensive money restricts it.
The Fed can only directly control short-term interest rates; affecting long-term rates is more complicated. Long-term rates are often tied to the yield on similarly maturing U.S. Treasuries or the corresponding swaps market. Granted, this is a bit simplistic, but it covers most cases. Long term rates are affected by a wide range of global factors, including the strength of other economies and market risks. Just because the Fed changes short-term interest rates, does not necessarily mean long-term rates will change.
The Grand Experiment:
When the 2008 global financial crisis hit, policy makers and elected officials had to move quickly to avoid a complete economic meltdown. They had to act with limited data and an opaque sense for how their actions would affect the future. It's easier to argue in hindsight about whether steps taken were correct, but I would suggest that in 2008 the Fed, as well as our elected officials, were presented with an incredibly complex set of circumstances driven by the global interrelationship of our economies and the nature of the cascading default risk. Generally speaking, the Fed and our elected officials did the best they could with the tools they had to prevent an immediate meltdown. They tried to stabilize the situation and then look for ways to promote growth. Quantitative easing, like it or not, is an example of this strategy.
The problem is that then, as now, nobody really knows how this grand economic experiment will end. Many scholars and politicians have argued that the monetary policies of the last eight years would be massively inflationary. So far, that outcome is not obvious. If anything, the world has ended up in more of a sideways recovery similar to what Japan has experienced over the last decade. In the U.S., we are seeing signs of economic vibrancy, but it's not like we're on a ballistic growth trajectory. After eight years of multiple QE's and basically 0 percent rates, were are barely treading water. The issue is more challenging for some of our major trading partners in Europe and Asia whose economies are in reverse. They are cutting interest rates, even going negative on rates to promote growth and avoid stagnation, or worse, deflation.
We Are In This Together:
While the fact pattern that has shaped global monetary policy over the last eight years is incredibly complex, how we unwind from such policy and "normalize" is equally complicated with ramifications that can have vast consequences for both the U.S. and the rest of the world. What happens in Europe and Asia really matters to the U.S. – we are forever economically tied at the hip with the rest of the world. Janet Yellen understands this. If some of our major trading partners are cutting rates to promote growth, it makes it hard for the U.S. to raise rates – every time one of our major sovereign competitors reduces their rates it translates into an imbedded rate increase for us. Every time we raise rates in the face of struggling economies abroad we strengthen the U.S. dollar, making our goods less competitive overseas and damaging global profits. Our economy is not yet so bullet proof that we can afford a major monetary policy gaff. If we are not careful, we could be right back into recession – a recession where we have limited tools left to fight; one, if not controlled, could spin into deflation. That's hardly a decision that should be left to politics.
The Path Forward:
The U.S. Central Bank should absolutely look for ways to carefully unwind from the monetary policies of the last eight years; it should take every chance to raise short-term rates. However, the Fed must do so in a measured way, being conscious of the global ramifications and subsequent potential impacts at home. Janet Yellen understands this. Donald Trump's comment that Yellen is protecting Obama is nonsense. This has nothing to do with Obama and everything to do with promoting sustainable economic growth while seeking pragmatic ways to engineer a soft landing from the last eight years. Yellen will continue to carefully probe ways to normalize while measuring the impacts to every piece of our economy. Her interests and legacy are aligned with this country – she understands that how she and her team navigate these treacherous waters has long-term implications for every one of us – she is not concerned with the short-term, and sometimes conflicted, interests of elected officials.
By the way, if we had not embarked upon the monetary policies of the last eight years, I would bet Donald Trump's real estate business would be toast – after all, he admits he is the "King of Debt." The historically low rates of the past years likely allowed him to sustain high leverage on his portfolio over a longer period thereby saving his kingdom. Instead of criticizing Yellen, he should be on his knees thanking her (and Bernanke).