Monday, October 12, 2015

The IMF and the Fed

The IMF is meeting in Lima, Peru this week.  At this meeting, central bankers around the world are calling on the US to raise short term interest rates.  How are they supposed to do that?  The Fed has been wondering about that for a while.  What neat, simple mechanism, that won't start a panic, can the Fed use to raise short rates.  Certainly, the Fed discount rate is not powerful enough to do the trick.  So, how, in reality, can the Fed accomplish a higher rate regime?

Before tackling that never-asked question, what about the question of why rates are so low in the first place and why they have been low ever since the 2008 financial collapse?  Is it really the Fed?  Why are rates so low in Germany, there is no Fed in Germany? Is the Fed really the key to short term rates?  Not likely.

Since 2008, securities that were thought to be relatively riskless have all but disappeared because of arbitrary US government actions, breaking bond covenants and otherwise adding unknown and uncertain risks to other instruments that used to be substitutes for treasuries -- short term corporate obligations, for example.  You never know where the Obama Justice Department will strike next overturning long standing precedent and arbitrarily fining their political enemies.  Henry the eighth had nothing on the Obama Administration.

With the enormous uncertainty about arbitrary government seizures and fines -- commonplace today, virtually non-existent in the past, only US treasuries and overnight repos seem to offer, for now, a safe harbor from the caprices of the Obama Administration.  To big to fail is now enshrined policy, but those protected are now subject to arbitrary government action, partially offsetting the apparent guarantees in place.

So, what can the Fed do?  They can begin to unload their enormous balance sheet onto the market, suggesting an unprecedented upward explosion in financing rates.  This is a delicate operation, because the market cannot aborb that much debt in a short time without severe dislocation. If the liquidation of the Fed balance sheet occurs over a longer period of time, it will crowd out marginal borrowers and keep downward pressure on an already moribund economy.  So, what to do?

Meanwhile the IMF, which is now broke itself, is offering advice, which is pretty amazing if you think about it.  The original mission of the IMF was to smooth currency imbalances.   Now, they fund Greece.  So, is it any wonder they are out of chips and full of advice.

The Fed, the IMF are not instruments that can provide economic growth, though they can certainly create a lot of mischief, which they have.  Economic growth is a result of individuals, acting in their own limited sphere, creating economic progress, broadly defined, that leads to a surge in GDP per capita and dramatic increases in the standard of living of the average person.  The rule of law, rudimentary education and free markets are all that are needed.  Unfortunately, those three items are not on the US agenda, not on the Fed agenda, and not on the IMF agenda.

Somehow, it is always the wizard behind the curtain that is expected to pull a rabbit from the hat.  But, the reality is that real economic growth comes from the efforts of individuals trying to better their condition and a government that gets out of the way and lets them do that.

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