Posts Tagged ‘Federal Reserve’

file0001742232424The UK economy grew by 0.7 per cent in the second quarter of 2015, and by 2.6 per cent over the past year. The US economy grew at an annualised pace of 2.3 per cent. The media and markets greeted the figures with relief, but they were wrong.

To understand why, first consider what things were like in the first quarter of this year. The UK grew by 0.4 per cent, that’s quarter on quarter, and the US grew by 0.6 per cent– annualised. Actually, the data for Q2 had been revised upwards, so the markets had a kind of double celebration. They were chuffed by the okay figures for Q2, and even more chuffed by the upwards revision for Q1. Even so, bear in mind that in the latest quarter both the UK and US economies grew at a rate that was still way below average. As for Q1, the data may say that the US grew by 0.6 per cent annualised in Q1, but frankly that is a pretty awful performance. It’s just not as awful as the figures originally suggested. It is like coming last in a race, and then celebrating because the judges discovered they had made a mistake and in fact you only came second from last.

History tells us that economies tend to enjoy a period of above average growth when coming out of recession. History tells us that when an economy suffers a one off shock, which is supposed to have been what happened in Q1 of this year, then the following quarter should expand at a faster than normal pace to make up for the lost production of the previous quarter.

We are told that poor figures on the first quarter were down to a shockingly bad winter in the northeast corner of the US. This even affected US imports to the UK, knocking the UK economy. If that is so, however, shouldn’t the second quarter have seen unusually fast expansion, making up for lost ground?

In the US, the Federal Reserve is losing patience, it will be a big surprise if US interest rates don’t go up very soon, September most likely. Rates will be rising in the UK soon too, probably January.

Once again, consider the lesson of history. The Fed increased rates in 1994, after a period in which they had been at 3 per cent for 18 months or so. A year and a half later, US interest rates were at 6 per cent. Crisis soon followed, however. The global economy had got used to low US interest rates, when they rose capital left developing markets and headed west. We had the Asian crisis of 1997 and the Russian crisis of 1998. The global banking system tottered.

A similar story occurred all over again the following decade. This time though, US rates were cut to 1 per cent, stayed there for about a year, and then gradually began to rise. Within a year or two, come 2008, the global banking system did more than totter, it fell over. We all know how nasty that was.

This time US rates have been at near zero per cent for almost seven years. As they rise, the shockwaves across the world will be nasty.

The problem is compounded. Critics of the Fed say that by cutting interest rate to near zero, it has nothing left to give in the event things make a turn for the worse. The snag with that is that if the Fed hadn’t cut rates so low its economy may have suffered an even more nasty turnaround. It is like a runner in a race, holding back for a sprint finish. But if the race leader sets a fast pace, and our runner goes with the leader and has the sprint run out of him, or indeed her. You can’t criticise the runner for going too fast, there was no choice.

In short, rates are low because they had to be, now they are rising because they have to. Neither the US or UK economy are strong though, indeed they are more like a wheezy athlete, about to start a long uphill climb.


Who needs central bankers anyway? It’s a view often expressed by the more adamant supporters of the markets.

This is what Nassim Taleb had to say on this very matter in his book ‘Anti Fragile’: “Ask a US citizen if some semi-anti governmental agency with a great deal of independence (and no interference from Congress) should control the price of cars, morning newspapers and Malbec wine….He would jump in anger as it appears to violate every principle the country stands for, and call you a communist post-Soviet mole for even suggesting it. Then ask him if the same government agency should control foreign exchange, mainly the rate of the dollar against the euro and the Mongolian tugrit. Same reaction: this is not France.

Then very gently point out to him the Federal Reserve bank of the US is in the business of controlling and managing the price of another good , another price called the lending rate, the interest rate in the economy (and has proved to be good at it). The libertarian presidential candidate Ron Paul was called a crank for suggesting the abolition of the Federal Reserve or even restricting its role. But he would he also have been called a crank for suggesting the creation of the agency to control other prices.”

Losing candidate for Vice President at last year’s US election Paul Ryan is also an arch critic of central banks, and about as anti QE as you can get.

Now enter stage right a new currency. It’s called the Bitcoin, and was launched in 2009 by a developer with the pseudonym Satoshi Nakamoto. It’s a virtual coin, existing solely on the Internet. You can buy goods and services in Bitcoins, and your store of Bitcoin wealth exists in a kind of virtual wallet.

Although the Bitcoin may not have been designed specifically for this purpose, it is often used to purchase illegal goods.

The supply of Bitcoins – if you like the money supply – is controlled by algorithms. There is no central bank; instead a peer to peer network controls this currency via the forces of the market. At the beginning of this month the monetary base was said to be around $1 billion.
So this is an experiment in libertarian economics. Will this new fiat currency replace those that are artificially controlled by central banks?

There is a snag. And the snag comes in the guise of a bubble. The price of a Bitcoin – or if you like, its exchange rate – has doubled in two weeks and, according to the ‘FT’, the monetary base is now worth $1.5 billion.

UBS stockbroker Art Cashin said in a note to clients: “Trading tulips in real time…It is rare that we get to see a bubble-like phenomenon trade tick for tick, but all that may be changing before our very eyes.”

The Cypriot crisis has not helped, with the currency’s supporters describing it as an alternative to conventional currencies.
But is the rate at which is value is soaring sustainable? Probably not. Is it a bubble: probably.

But the question is: does it matter?

In a world of no central banks, and currencies that are solely controlled by markets, failure is essential for correcting errors and for punishing over-exuberance. According to libertarian economics, market forces ensure recessions are only ever short lived affairs.

But are the libertarians right? Perhaps they are, but just remember that in nature – that ultimate example of a free market – growth is not automatic; change often only occurs after some kind of natural disaster, and sometimes evolution can throw up inefficient quirks such as peacocks, whose colourful appearance makes the male attractive to potential mates, but easy prey.

©2013 Investment and Business News.

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