August 19, 2015
The US economy continues to grow slowly, to add jobs without driving wages higher, to see increased profits from businesses without spurring new business investment. Year after year, quarter after quarter, 75% or more of corporations report profits that beat estimates, but instead of raising salaries or hiring workers fast enough to bid up wages due to competition, they instead issue dividends or buy back their own stocks to increase Earnings Per Share (by reducing the denominator of that indicator--the number of shares). Companies mostly borrow (issue bonds) at very cheap interest rates to do this. And if regular people (not corporations) have any savings, the interest rates they get on these are incredibly low, too.
Many observers have been waiting for interest rates to go up, but they've been near zero for years now. As we approach the seventh anniversary of the collapse of Lehman Brothers (the match that lit the 2008 recession), why do we continue to have such low interest rates, low wages, and low business investment, even as corporations prosper and the number of jobs rises?
It's because inflation is too low--so low that our economy is actually close to a much scarier phenomenon: deflation. Month after month there are new reports of inflation being too low. This is why the Federal Reserve has refused to raise interest rates for the past several years. A rise in interest rates that might help people's savings accounts would send the already anemic economy into a new recession, as borrowing & spending slowed ground to a halt.
The Federal Reserve has kept interest rates at near zero for years, and spent many years (until last fall) engaged in "Quantitative Easing," shoveling huge amounts of money "out the door" of the Fed in order to buy bonds, increasing the total supply of money in the economy. Why haven't these huge increases in the money supply caused inflation. Even with the supply of dollars up, and easy terms to borrow more dollars, the cost of products & services hasn't gone up--in fact, gas, oil, and some foods have dropped!
Moreover, internationally the demand for dollars has been outstripping supply. The number of euros, Chinese yuan, Brazilian reais, Russian rubles, and other currencies it takes to buy a dollar has gone up--the dollar is more expensive, and stronger than its been in a decade. If the Fed has kept the supply of dollars up, the "price" of dollars in other currency should have come down, but the opposite has happened. And now, with a new devaluation of the Chinese yuan last week, it takes even more yuan to buy a dollar. This means that Chinese products are about to become even cheaper in the United States. American producers will have to lower their prices in order to compete with such products--when prices come down across the board, this is the definition of deflation (and leads to shrinking profit-margins, laid-off workers, and less consumer spending: a downward spiral).
In general, despite everything the Fed has done to try to get inflation up to a healthy level (2% is deemed by the Fed, the IMF, the Bank of England, the European Central Bank, and most economics to be far enough from zero to avoid the threat of a deflationary death-spiral, the like of which the United States and the whole world experienced in the 1930s), nothing seems to work. Monetary policy seems incapable of returning the dollar to an appropriate rate of inflation that could tolerate a normal set of interest rates, where you'd make a decent return on a Certificate of Deposit or other reliable means of savings. Why?
The answer is Fiscal Policy. If Monetary Policy has to do with interest rates and the impact that a central bank (ie, the Fed) has on the supply of money in the economy, Fiscal Policy has to do with the government budget's impact. Across the country, states have been "tightening their belts" for almost a decade, firing teachers, other government employees, cutting spending in response to the aftermath of the 2008-09 recession. By cutting the number of dollars they emit into the economy, governments are shrinking the money supply that the Fed has been trying to maintain.
But state governments' spending is tiny compared to that of the Federal Government. And it has had a huge negative effect on the money supply. This is because every year since 2009, the US government has been reducing the (net) amount of money that it puts out into the overall money supply. The US government puts money into overall money supply every year by spending more money than it takes in in taxes--running a budget deficit. It does not do this all the time (for example, at the end of Bill Clinton's presidency, the US ran a surplus for several years: it was actually taking money out of the money supply, instead of adding it--but during that period, inflation was rising, so it fit in exactly with the goals of macroeconomic management). But the US has run a budget deficit in all but four years since 1970, meaning the budget is a major factor contributing to the money supply--a budget in deficit increases the money supply, and can help avoid deflation.
But while the US budget deficit spiked in 2009 from about $450 billion to over $1.4 trillion ($1,400 billion), beginning in 2010, the budget deficit has been cut every year, and in 2015 it's projected to be just $425 billion. By cutting the budget deficit every year, the US government has been gradually closing the tap on its contribution to the money supply, working directly cross purposes with the Federal Reserve's efforts to return inflation to a normal level where it can safely hike interest rates. The continued voracious appetite for budget-cutting in the US Congress will certainly exacerbate this situation in the future, and doom us to a new normal of economic anemia.
Until the Congress ceases stymieing the Federal Reserve's efforts to manage inflation, interest rates, and the money supply, we are in for low inflation, low interest rates, continued wage stagnation, and businesses continuing to return cash to investors, instead of investing it in new production.
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