The world is messing with the Fed – so said the headline of an article in the US print edition of the Wall Street Journal over the weekend. The article explores the different weight of the impact between US domestic considerations and global economic conditions on the Fed’s rate change decision.
As we know the Fed did not raise rates last week – I had predicted as much on August 18th. The main reason cited by Janet Yellen, Fed chief, was that global concerns regarding the economy outweighed current US domestic considerations. This argument only works up to a point. In the 1930’s the US explicitly altered its own domestic monetary policy at just the wrong time for the global economy; the plan to return to gold was blown up by newly elected Roosevelt, even as the main trading nations were in conference and the results of this introverted act was disastrous for all. See London Economic Conference 1933.
The main cause of the current perturbation in the global economy derives from China. China’s economy had become a significant component of global growth – and so its economic slowdown is dragging everyone else down with it. More specifically its slowdown is depressing commodity prices globally and the impact can be seen in corporations and nations around the world. Headlines everyday include another business struggling to cope with a drop off in demand from China.
Related to the slowdown in China is the shale-bonus: depressed oil prices, which acts as a double-whammy on some of those same corporations struggling with commodity deflation, while at the same time helping various domestic consumer segments with lower costs. All this acts in the same direction and leads to significant drag on prices overall and so what economists call deflation. Only today there was another article in the US print edition of the Wall Stree Journal highlight yet more downward pressure on prices in the Eurozone. See Eurozone Faces New Threat of Deflation.
The result of this complexity is that the models our leaders have are not working. They have moved the levers, sometimes to extreme positions (think of QE) and yet things are not moving as expected. The political machinery that wraps around the monetary and fiscal policy framework is in a funk at just the wrong time: the inability to get to a consensus on one direction or another (i.e. spend your way out of the hole, or cut your way out) has left the global economy adrift in the eddy of stagnation.
It really does not matter which approach we take – we need to take one. Even if we elected to try the Keynes way, we know that it would blow-up and cause a real crash that would finally weed out all the dead wood that government debt has been nurturing to protect. Even that would be a fair price to pay to get us out of this cathartic dilly dallying loser of a race.