The world has risk-laden problems to solve. Higher borrowing rates are indicia of higher risks to returns on capital, but the cries for lower rates do not appear to resonate with capital’s search for high returns that compensate for higher risks. If the Federal Reserve System is to meet its statutory dual mandate of stable prices and full employment, then it first must meet its hidden mandate which is to facilitate the value of the United States dollar.
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The Federal Reserve System’s primary tool for making the USD attractive is its administered rates. It can only do so much with this tool. Is it doing enough?
Proponents of lowering the Federal Reserve System’s discount window rate, interest on reserve balances, and federal funds target rate argue that lowering these rates will help stimulate the macro economy. Lower borrowing rates should be offered by lenders as a result of lowering the above rates and targets. We do see a change in bank lending rates when the Federal Reserve System announces a rate change. We also see, in general, an increase in asset values and prices given the inverse relationship between asset prices and interest rates. A fall in interest rates should increase the value of collateral brought to the table by a borrower which should allow her to borrow more capital that is later deployed in the economy.
Proponents of a rate increase see higher rates stimulating growth as well. One low hanging fruit argument is that in this higher for longer interest rate environment, we are seeing resiliency in the economy. My street view of spending in Atlanta leads me to conclude that a recession is not here yet and a number of economists have had to admit that their calls for economic doom by the end of 2023 had not been met. A number of commenters are still amazed that even after savings sourced by the issue of stimulus checks have dried up that people are still spending.
Yesterday’s release by the U.S. Bureau of Economic Analysis of the personal consumption index may give the doomsayers a glimmer of hope that their recession calls were merely delayed and not evaporated. Gross domestic product, the U.S. measure of macro income or output, increased on an annualized basis by 1.6% as measured in the first quarter of 2024. This is down from the annualized rate measured in the third quarter of 2023 of 3.4%. The traditional measure of recession, two straight quarters of negative GDP, may not have been met, but yesterday’s BEA report shows a slowdown in growth, one that may keep the Federal Reserve from implementing a decrease in its administered rates.
Assuming that the doom and gloom of recession may surface in 2024, higher rates may provide a beacon by directing scarce capital to activities of higher return. Higher rates may cause asset holders to pursue more innovative approaches to generating income from their assets. Rather than bringing mere owner equity as collateral, the asset holder could argue that the value of the asset should be determined by the rents the asset earns thus differentiating itself from similar assets held by other potential borrowers.
Higher rates encourage asset holders to deploy their assets to solve high value problems. Lenders in a high interest environment will approve business models that solve high value problems.
To many this sounds counter-intuitive and is definitely a minority position. The prevailing view particularly amongst money managers is that the Federal Open Market Committee will have at least two rate cuts this year although unlikely occurring during its April 30-May 1, 2024 meeting.
A minority position can increase in significance with constant and targeted advocacy. The mystique surrounding the Board of Governors of the Federal Reserve System and the Federal Open Market Committee distracts from the fact that they can be subjected to political pressure via the public. Too often the advocacy is left up to congressmen, most of whom demonstrate a lack of ability to connect the decisions of the Federal Reserve System to the decisions made by traders and consumers.
Are you ready to implement sound money policy?
Alton Drew
26 April 2024
For more of my view on the American political economy, buy my book at amazon.com/author/altondrew.
Disclaimer: This post should not be viewed as legal or financial advice. Please consult an attorney or financial advisor before making an investment decision. Alton Drew is compensated if you buy product you are directed to when clicking on affiliate links. Please also visit the advertisers appearing in this post.
Alton Drew 