By Raz Koroh
Fed chairwoman Janet Yellen is in a dilemma. Her task is to resuscitate the post 2008 crisis U.S. economy and at the same time she is expected by her critics to recalibrate U.S. interest rate from its historic low rate of zero per cent in case that a future recession necessitates the Fed to unleash its monetary weapon rather than (understandably) Congress having to approve a painful deficit spending. Well, she had already raised interest rate by 25-basis points last December, but her critics want more and fast. As it is, Yellen has had to protect the Fed’s independence from the U.S. Congress attempt to effectively take control of monetary policy making via the Fed Oversight Reform and Modernization Act (FORM); Congress simply cannot understand why the Fed is not acting in accordance to benchmark economic data (jobs, inflation, etc.) but instead has other vague ways of assessing the U.S. economy. This gives the impression that every time Yellen gives a speech in front of a Congressional committee, she would say something that they like to hear rather than what she actually thinks is best for the economy. Indeed, luckily for Yellen, the uncertainty surrounding the global economy gives a good enough reason not to raise rate in the coming months; at least this temporarily lifts the pressure off her. In any case, there are the optimists who persistently argue that as the U.S. economy is mainly driven by consumers, then seemingly rosy job data should power the nation into a high growth economy. Yellen should not be too worried, so they argue. Are they really correct?
Here are several factors to consider.
INFLATION. The low oil price distorts the real U.S. inflation rate. This is common knowledge, but it does not mean that real inflation rate is up, for there is no way to tell. Even if we exclude oil from the calculation, the resultant ‘non-oil’ inflation rate will still be distorted, as almost everything that is consumed has some portion where energy is included in the cost of production, which will then be passed on to final consumers as retail price. The impact of oil price is more immense in logistics in general, and almost everything needs to be transported to our suburban supermarkets. The Fed cannot possibly take the latest adjusted inflation rate as any indication that the U.S. economic growth is back to its desired level.
UNEMPLOYMENT. The latest data may indicate that U.S. unemployment rate is at an acceptably low level. But this obscures the fact that a lot more employable people have given up on looking for employment, meaning that the U.S. is experiencing a declining workforce participation rate. It also obscures the fact that of those presently employed, a good 5 to 10 per cent of them are underemployed (i.e. the broader unemployment rate); current data puts unemployment rate at 5.1% but the broader rate at 10.3% (compared to 10% and 9.2% in early 2008). This shows that almost all the post-2008 employment gains come from part-time employment and here is another shocking fact – more than half of the recent added jobs come from government, education and healthcare, and not from industries that are exposed to the market that better reflects if the economy has recovered or not. For the Fed, this means that the unemployment data is not a reliable indicator that the U.S. economic growth is back to its desired level.
STAGNANT WAGES. Put simply, wages have not increased for several years already. This indicates that the U.S. economy is not experiencing a cyclical problem, but more of a structural one. Weak wage growth is indicative that there are more people looking for work than there are jobs available for them. Although this does not automatically mean a lack of investment opportunities in the U.S. economy, it does indicate a lack of suitable labor supply for potential investment. Unless the labor surplus problem is speedily resolved by those in charge of retraining, then the problem will persist. There is nothing the Fed can do on this and it means that it will have to accommodate future investment needs once the imbalanced labor supply situation is resolved. In short, it had better just wait and see what happens. The last thing that the Fed should do is to prematurely raise interest rate and discourage future investment, and thus sabotaging the nation’s economic growth.
EXCHANGE RATE. Since 2010, the U.S. dollar has appreciated against currencies of all its major trading partners – the euro (from 0.75 to 0.92 per dollar), the yen (from 81 to 117 per dollar). The Chinese yuan in contrast has appreciated slightly against the dollar, and this means both the U.S. and Chinese currencies need to depreciate against the euro and yen by around 20 to 30 per cent to regain export competitiveness for their economies. Although this is more so for China than for the U.S., the fact that global trade is less critical for the U.S. economy does not mean that the broader investment climate inside the U.S. is immune to the strong dollar. The gradual hallowing out of the nation’s globally oriented manufacturing sector, with U.S. multinational corporations attracted to weaker currency export bases relocating overseas, leaving hundreds of thousands of U.S.-based workers stranded and looking for new jobs they are ill-prepared for, does affect the consumer base of the economy. This is evidenced in the low consumption, high investment in post-industrial sectors not matched by the nation’s still industrial-age workforce, and in the end lower than it should be economic growth and the low inflation that the U.S. economy experiences today.
Whether to raise the interest rate or not, the Fed will have to consider two alternative scenarios – on the one hand, if by raising interest rate, consumption, investment and trade are prematurely curtailed, the immediate impact will be on economic growth and consequently unemployment rate, and this can easily spiral to even worse situation than it already is at present; on the other hand, if by staying put for a little while longer, the nation’s structural labor problem is gradually resolved, and only then new investment finds its proper place in the economy. The only worse thing that can happen in the meantime is that the asset bubble economy will try to find its way back in once again because of low interest rates. But surely, this fear is no excuse for neglecting the real economy, and the Fed is very mindful of this.