A Federal Reserve Primer and Why You Don’t Need To Worry About Interest Rates Today

A Federal Reserve Primer and Why You Don’t Need To Worry About Interest Rates Today

(Photo: AP Photo/Andrew Harnik, File)

Last weekend, the Federal Reserve Board’s leadership met to discuss the future of America’s monetary policy. Reports out of that meeting, like reports from all Fed meetings, are long, tedious, and pretty much say nothing. Every analyst tries to interpret from the governors’ statements what might happen next. And because the Fed leadership is so vague, and so academic, the analysts inevitably never guess right.

End the Fed
This bothers a lot of people. There are those who want a lot more “transparency” from the Fed – meaning they want much clearer signals as to what is intended, and usually specifics as to intended actions and a timeline. Because the Fed’s meetings are so cloaked and opaque, some congress members actually want to do away with the Fed, or regulate it a lot more closely.

But for most of us, most of the time, the Fed is pretty much immaterial. When the Fed matters is when there are big swings in the economy, which happen quickly. Then their action is crucial.

 

Why Small Changes In Interest Rates Don’t Really Matter To Most Of Us

Take the debate right now over a quarter point rise in interest rates. How does this affect most people? Not much. If you have credit card debt, or a car loan, your interest rate is set by the financial institution. And you may hear people talk about zero interest rates, but you know your rate is a whopping amount higher than that. And you know that a quarter point change in the Federal Funds rate will not affect the interest on those loans.

Where you’ll see a difference is in a mortgage. But here, is a quarter point really important?

When I graduated business school in 1982 and wanted to buy my first home the interest rate on an annual, variable rate loan was 18.5%. My first house cost just about $100,000 so the interest was $18,500/year. Today, mortgages are around 3.5%, fixed for anywhere from 3 to 7 years. $18,500 in interest now funds a $525,000 mortgage! If interest rates go to 3.75% – which has many analysts so concerned for the economy – the home value associated with interest of $18,500 is $500,000. Probably within the negotiating range of the buyer.

So you have to borrow a LOT of money for this quarter point to matter. And it does matter to CEOs and CFOs of companies that lead corporations on the S&P 500, or those running huge REITs (Real Estate Investment Trusts) that have enormous debts. But that is not most of us. For most of us, that quarter point difference will not have any impact on our lives.

So Why Do People Pay So Much Attention To The Fed?

The Fed was originally created barely 100 years ago (1913) to try to create a more stable monetary system. But this didn’t work too well in the beginning, which led to the Great Depression. And then, to make matters worse, the conservative bent of the Fed coupled with its fixation on stable interest rates led it to actually cut the money supply as the economy was tanking. This led to a collapse in the value of goods and services, particularly real estate, and the loss of millions of jobs greatly worsening the Great Depression.

It was the depression which really caused economists to focus on studying Fed actions and the economic repercussions. A group of economists, most notably Milton Friedman at the University of Chicago, started saying that the Fed shouldn’t focus on interest rates, but rather on the supply of money. These folks were called “monetarists” and they said interest rates should float, and economists should focus on stable prices.

The 1970s – “Easy Money” Inflation

As we moved into the 1970s, and as Fed Governors kept trying to control interest rates, they found themselves creating more and more money to keep rates low, and in return prices skyrocketed. “Easy money” as they called it allowed ratcheting upward incomes, big pay raises, higher prices for commodities and inflation. Another monetarist leader, Paul Volcker, was named head of the Fed. He rapidly moved to contract the money supply, allowing those 18.5% mortgage rates to develop. Yet, this did stabilize prices and eventually rates lowered, moving down constantly from 1980 to the near zero rates of today for Treasury Bonds and other very large, low risk borrowers.

When the Great Recession hit the Fed leadership, led by Ben Bernanke, remembered the lessons of the Great Depression. As they saw real estate values tumble they were aware of the domino effect this would have on bank failures, and then business failures, just as they had occurred in the 1930s. So they flooded the market with additional currency to keep failures to a minimum, and ease the real estate collapse. This sent interest rates plummeting to the record low levels of the last few years.

Policy Must Address The Current Situation, Not Be Biased By Historical Memories

Yet, people keep worrying about inflation. Those who lived through the 1970s and saw the damage done by inflation are still fearful of it. So they scream loudly about their fear that the last 8 years of monetary ease will create massive future inflation. They want the Fed to be much tighter with money saying that all this cash will someday create inflation down the road. Their view of history is guiding their analysis. Their bias is a fear that “easy money” once caused a problem, so surely it will cause a problem again.

But economists who study prices keep saying that there are currently no signs of price escalation – that wages have not moved up appreciably in a decade, home values are barely where they were a decade ago. Commodity prices are not escalating, in fact many (like oil) are at historically low prices. The dollar is stronger because, relatively speaking, the USA economy is doing better than the rest of the developed world. As long as prices and wages remain without high gains, there is little reason to tighten money, and little reason to feel a higher interest rate is needed.

Further, past monetary increases will not cause future inflation, because monetary policy only affects what is happening now. “Easy money” today can only create inflation today, not in 3 years. And inflation is almost nowhere to be seen.

Ignore Fed “Fine Tuning.” Pay Attention When A Crisis Hits. Otherwise, It’s Up To The Politicians

The big thing to remember is that small changes in policy, such as those that might affect a quarter point change in rates, is “fine tuning” the money supply. And that has pretty nearly no affect on most of us. Where as citizens we should care about the Fed is when big changes happen. We don’t want mistakes like happened in the 1930s, because that hurt everyone. But we do want fast action to deal with a crisis like the falling real estate values and bank collapses that were happening a decade ago.

Remember, it was when the Fed targeted interest rates that the USA economy got into so much trouble. First in the Great Depression, and then in the inflationary 1970s. But when the Fed targeted prices, such as in the 1980s and the mid-2000s, it did exactly what it was created to do, maintain a stable money supply.

So don’t worry about whether analysts think interest rates are going to change a quarter point, or even a half point, in the next year. The big economic question facing us is not a Fed question, but rather “what will it take to increase investment so that we can create more jobs, and provide higher wages leading to a higher standard of living for everyone?” And that is not a question for the Fed to answer. That is up to the economic policy makers in the legislature and the White House.

Hobby Lobby – Win the Battle, Risk Losing the War

Hobby Lobby – Win the Battle, Risk Losing the War

Yesterday the U.S. Supreme Court ruled in favor of Hobby Lobby and against the U.S. government in a case revolving around health care for employees.  I’m a business person, not a lawyer, so to me it was key to understand from a business viewpoint exactly what Hobby Lobby “won.”

It appears Hobby Lobby’s leaders “won” the right to refuse to provide certain kinds of health care to their employees as had been mandated by the Affordable Care Act.  The justification primarily being that such health care (all associated with female birth control) violated religious beliefs of the company owners.

As a business person I wondered what the outcome would be if the next case is brought to the court by a business owner who happens to be a Christian Scientist.  Would this next company be allowed to eliminate offering vaccines – or maybe health care altogether – because the owners don’t believe in modern medical treatments?

This may sound extreme, and missing the point revolving around the controversy over birth control.  But not really.  Because the point of business is to legally create solutions for customer needs at a profit.  Doing this requires doing a lot of things right in order to attract and retain the right employees, the right suppliers and  customers by making all of them extremely happy.  I don’t recall Adam Smith, Milton Friedman, Peter Drucker, Edward Demming, John Galbraith or any other historically noted business writer saying the point of business to set the moral compass of its customers, suppliers or employees.

I’m not sure where enforcing the historical religious beliefs of founders or owners plays a role in business.  At all.  Even if they have the legal right to do so, is it smart business leadership?

Hobby Lobby Store

Hobby Lobby Store

Hobby Lobby competes in the extraordinarily tough retail market.  The ground is littered with failures, and formerly great companies which are struggling such as Sears, KMart, JCPenney, Best Buy, etc.  And recently the industry has been rocked with security breaches, reducing customer faith in stalwarts like Target.  And profits are being challenged across all brick-and-mortar traditional retailers by on-line companies led by Amazon, who have much lower cost structures.

All the trends in retail bode poorly for Hobby Lobby.  Hobby Lobby does almost no business on-line, and even closes its stores on Sunday. Given consumer desires to have what they want, when they want it, unfettered by time or location, a traditional retailer like Hobby Lobby already has its hands full just figuring out how to keep competitors at bay.  Customers don’t need much encouragement to skip any particular store in search of easily available products and instant price information across retailers.

Social trends are also very clear in the USA.  The great majority of Americans support health care for everyone.  Including offering birth control, and all other forms of women’s health needs. This has nothing to do with the Affordable Care Act.  Health care, and women’s rights to manage their individual reproductiveness, is something that is clearly a majority viewpoint – and most people think it should be covered by health insurance.

So, given the customer options available, is it smart for any retailer to brag that they are unwilling to offer employees health care?  Although not tied to any specific social issues, Wal-Mart has long dealt with customer and employee defections due to policies which reduce employee benefits, such as health care.  Is this an issue which is likely to help Hobby Lobby grow?

Is it smart, as Hobby Lobby competes for merchandise from suppliers, negotiates on leases with landlords, seeks new store permits from local governments, recruits employees as buyers, merchandisers, store managers and clerks, and seeks customers who can shop on-line or at competitors to brandish the sword of intolerance on a specific issue which upsets the company owner?  And one where this owner is on the opposite side of public opinion?

Long ago a group of retired U.S. military Generals told me that in Vietnam America won every battle, but lost the war.  Through overwhelming firepower and manpower, there was no way we would not win any combat mission.  But that missed the point.  As a result of focusing on the combat, America’s leaders missed the opportunity win “the hearts and minds” of most Vietnamese.  In the end America left Vietnam in a rushed abandonment of Saigon, and the North Vietnamese took over all of South Vietnam.  Although we did what leaders believed was “right,” and fought each battle to a win, in the end America lost the objective of maintaining a free, independent and democratic Vietnam.

The leaders of Hobby Lobby won this battle.  But is this good for the customers, suppliers, communities where stores are located, and employees of Hobby Lobby?  Will these constituents continue to support Hobby Lobby, or will they possibly choose alternatives?  If in its actions, including legal arguing at the Supreme Court, Hobby Lobby may have preserved what its leaders think is an important legal precedent.  But, have their strengthened their business competitiveness so they will be a long-term success?

Perhaps Hobby Lobby might want to listen to the CEO of Chick-fil-A, which suffered a serious media firestorm when it became public their owners donated money to anti-gay organizations.  CEO Cathy decided it was best to “just shut up and go sell chicken.”  Business is tough enough, loaded with plenty of battles, without looking for fights that are against trends.