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Bye, Bye Federal Reserve Pie

The politics of rate hikes are increasingly irrelevant to the economy.

For years, the (old) left has been agog trying to discover the deep meaning of the number-one 1971 smash hit “American Pie.” Was it the end of America, or more profoundly of idealism, when “the music died”?

Neither music nor America died, but today there’s little left of idealism. Don McLean himself materialistically sold his handwritten “Pie” lyrics for $1.2 million. And capitalism’s big bank is still here, at least for now.

The all-powerful Federal Reserve, called by securities pro Ruchir Sharma “the world’s bank,” has just shown the world it cannot summon the willpower necessary to raise interest rates from 0.5 to 0.75 percent. Apparently, the extra 0.25 points would panic investors and maybe even threaten Hillary Clinton’s election.

But as two investment advisors who have consistently predicted the course of the post-crash market—Brian S. Wesbury and Robert Stein of FirstTrust Advisors—responded, setting the rates is meaningless anyway. The only magic the Fed does that counts fiscally concerns money.

Rates are Dumbo’s magic feather to make the elephant fly. The Fed under Janet Yellen has been panicked that raising rates, even by micro-measures, would be like taking the feather away from the big investors, who would otherwise crash right to the ground. Former chairman Ben Bernanke even whispered that “maybe this is one of those cases where you can’t go home again,” fearing ever to raise rates again.

Rates make no difference economically, but they do matter politically. As Sharma demonstrates with real data, “the S&P 500 has gained 699 points since January 2008 and 422 of those points came on the 70 Fed announcement days.” This is new. Between 1960 and 1980, Fed announcements had little effect, and between 1980 and 2007, Fed announcements had only half of today’s clout when it came to moving markets. When real estate value is added to securities, current asset valuations have never been higher over 50 years than they are today. Sharma concludes we now are witnessing an asset bubble that has been caused directly by the Fed’s easy money.

With the price-earnings ratio of the S&P 500 60 percent higher than its historic average, the economist Martin Feldstein fears that raising rates would cause the overvalued assets to fall and pull the economy down with them. But given that 60 percent of stock-market gains have come on dates the Fed has made a policy announcement, if the economy did fall, the cause would be the panic from a Fed political pronouncement rather than underlying economic reality.

I know as little about money and markets as about popular music, but perhaps I could translate economic gobbledygook into English relying upon Wesbury and Stein. First, the delusion: “The Federal Reserve has convinced itself, and many others, that it has ultimate control over the economy.” It does not. All the Fed can do is create or destroy bank reserves “by buying or selling bonds to or from banks. When the Fed buys bonds, it pays banks by creating new deposits” and through the money-multiplier effect creates growth in the money supply. “If the Fed sells, the process reverses and money tightens.” Thus, “when the Fed prints money it boosts spending because there is more money to spend,” but it is worth less, which is called inflation.

This is important. Rate hikes do not tighten money, because the Fed “has signaled it has no intention of selling any of the bonds it holds”—it will have the same $2 trillion in reserves whether it raises rates or not. It is more costly to borrow if rates increase, but two-tenths of a point frightens few when the core inflation rate has been 2.3 percent the past year so that actual rates are negative. As a result of Fed policy and growth-restricting regulations like Dodd-Frank, “all new money has been clogged up in the system and has not created [substantial] inflation or acceleration in economic activity.”

The bottom line is that “Negative interest rates are back-firing because you can’t force banks to lend when few good loans are available and as customers choose to hold cash instead of bank deposits” that pay little or no interest. Wesbury and Stein want the Fed to start raising rates gradually to reduce the political rather than economic power of the Fed, but they consider the “debate about when rates may rise” “a waste of time.”

The only solution is for the Fed to reduce its reserves (slowly), and Congress and the president must cooperate in reducing the government spending and destructive regulation that are crowding out productive investment. Wesbury and Stein are eternal optimists and hope somehow the government may wake up and at least slow spending and regulation so that what they call the current “plow horse” economy can at least struggle through, as it has for the past seven years of “recovery.”

For pessimists, it might just be bye, bye American pie.

Donald Devine is senior scholar at the Fund for American Studies and the author of America’s Way Back: Reclaiming Freedom, Tradition and Constitution, and was Ronald Reagan’s director of the U.S. Office of Personnel Management during his first term.



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