The Federal Reserve’s rate hike dance

Dialogue with the Alter Ego on the cautious Federal Reserve rate decision of Sep. 17

Question by Alter Ego of Noah denkt™ (AE): In a closely watched session on Sept. 17, the US Federal Reserve decided to leave interest rates unchanged. It justified its decision by invoking possible deflationary pressures that might arise from the economic slowdown in China, the related turbulences in currency markets and the contagion risk in financial and emerging markets. Noah denkt™ had earlier on presented ambivalent views about the likelihood of rate hike in September. And this project had also echoed Paul Singer’s damning 2014 remarks about faked inflation and faked unemployment numbers. How does Noah denkt™ consequently respond to the Fed’s holding decision now that it is actually on the table?

Answer by Noah denkt™ (Nd): Well, Noah denkt™ was still in Silicon Valley when the Fed decided to leave rates unchanged. And the one thing we can unambiguously say about the price level in the greater Bay Area is that there it doesn’t feel at all as if inflation were still below 2%. In fact, it isn’t. According to the Bureau of Labor Statistics, the core inflation (all items excluding food and energy) in the Western Region of the US was at 2,4 % in August 2015. And that of services less energy services was even at 3.3% (see: http://www.bls.gov/regions/west/news-release/consumerpriceindex_west.htm) – Now the Western Region comprises all of California and includes among others states like Alaska, Idaho, Montana, Nevada and Wyoming. So you can imagine what the true inflation rate in San Francisco, Palo Alto or San Jose is. In two words, it is “outright scary.” Obviously, we are well aware that the Bay Area is very much a case of its own. One can clearly describe it without hesitation as the world’s preeminent future lab. So some meaningful surcharge to the prices elsewhere is absolutely justified. But this present surcharge can be felt even beyond the traditional confines of Silicon Valley from Healdsburg and Calistoga up North to Sacramento in the East, to Monterey County further south. So it is hard to deny that some bubble is in the making here.

AE: In other words, you believe that it was a mistake not to raise interest rates?

Nd: We believe so. The sad truth, however, also is that the world economy is so distorted by money printing virtually everywhere in the world that the poor souls on the Federal Open Market Committee have an impossible job to do speculating about the future. After all, it can’t be denied that we are all dancing now on the rim of a potentially very active volcano.

AE: How much of a rate hike would you have favored?

Nd: Well, we probably would have opted for small, homeopathic rate hike just to test the water and to get done with the market’s paranoid fixation on that first upward move.

AE: So you do in fact think that the US economic recovery is sustainable. Why then do you keep hinting at the structural fragility of the world market? Does it really make sense to favor a rate hike when you basically presume that the devastating effects of the financial 2008 bubble still aren’t overcome?

Nd: Good point. But on the road back to sanity and to a new normal one may well have to embark on contradictory steps. After all, it is impossible to reach a new sustainable balance without having flickered in the face of some inevitable, yes even serious, pain. In other words, it seems more reasonable  to us to slowly reduce the amount of Keynesian distortion even at the price of potential adverse effects than to continue down the path of artificial growth.

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