In 1933 Franklin D. Roosevelt, President of the United States, did a “U turn” on the country’s allies in the face of economic disaster. The cost of the Great War had not been paid; reparations were unpaid; economic collaboration and agreement between the main nations about how to resolve the problems that were forcing currency collapse, inflation, and a ruinous fall in global trade, were vacant. But in the run up to the World Economic Forum in London in June, the US, UK and France were closer to an agreement than ever.
However, the newly installed Roosevelt famously “torpedoed” the conference and brought the whole idea of cooperation to the ground. He announced that the US would not stabilize its rate to gold and in effect, he stated that the US was less interested in helping the global economy than he was in improving the American situation. Though a good move for the local situation this was a ruinous decision for the globe. The result was the break up of any global coordination and the formation of several, smaller, currency zones – one being US dollar based, one on gold (what was left of it), one on the sterling area, and a few others. What happened then was a series of tit-for-tat valuation changes as each region or zone tried to improve its position with respect to the others. And of course the US did show signs of domestic economic improvement. However, the economic problems that were left rotting at the conclusion of the World Economic Forum were to forment and ultimately contributed to the causes of World War 2.
Janet Yellen, Fed Chair, is about to face her ‘Roosevelt moment’. In September 2015 the Fed decided not to raise rates as they declared that global economic concerns out weighted local domestic challenges. In December this position was reversed, and due to a “strong” employment market and signs of wage growth, domestic concerns outweighted global, and so rates were raised. This put the Fed on a very different footing to other central banks.
- The Eurozone and ECB are still in quantitative easing mode, and showing increasing signs for additional easing, and operating with negative interest rates
- China is easing in order to keep funding it’s debt fueled manufacturing but now slowing economy. China cannot change its economic model fast enough to a consumer model, less reliant on manufacturing, and so is stuck between a rock and a hard place. It’s falling demand is helping drive lower commodity prices (along with the oil glut) which in turn drives global deflation
- Japan just announced yesterday it’s move to negative interest rates as the BOJ tries to stoke inflation and drive growth through increased easing
- The UK is torn between the two positions – it’s economy has recovered and is growing reasonably, but it cannot raise rates easily without damaging its trade balance. Manufacturing and trade is a much larger proportion of its GDP then for the US. In the US consumer spending is about 60% of GDP – in the UK it is much smaller.
We have to realize to that this problem we face is man made, or shall we say, politician made. As fiscal and political policy changes needed to encourage growth have not materialized (tax reform, regulation reform, structural repairs, labor and wage liberalization etc.), the vacuum that our politicians created was filled by central banks in a vein hope to save their individual economies. However, there are two basic views of these efforts:
- Pro market view: rates should be increased, and fast, everywhere to encourage private saving that helps with reinvestment; reduce debt that is taken up by the private sector to fuel non productive share buy-backs and M&A; increase inflation; as an attempt to get back to normal market operations and normal investment decisions by firms and start-ups
- Pro economic view: keep rates low else we run the risk of unbalancing currency exchange rates thus damaging exports; try to encourage more loans by businesses so that they invest in capital improvement to drive growth and productivity; avoid damaging other efforts to keep those employeed in their job; hope that inflation returns
The pro market view is what is needed with global central bank coordination. This is not going to happen since we lack any kind of global leader. Can Fed Chair Janet Yellen continue to raise rates with these current headwinds? Looking back to 1933, a “go it alone” decision by President Roosevelt ended up not to be the best result, overall. The pro economic view will prevail since it is perceived to the less risky, and it actually seems to support the current tit-for-tat behavior of central banks that we see right now. As one central bank eases so the others have to, as an attempt to stabilize their position.
The result of this is a very tricky balancing act is that Janet Yellen, Fed Chair, is about to face that same Roosevelt moment. Will she line up with her peers and hold rates fast, or even lower them again, to help support the less risky pro economic view, or will she take the high road, and throw caution to the wind, and raise rates as it is the right thing to do? If there was hope that the other central banks could do the same, with collaboration, she would do this in a heart beat. As it is, her hand is nervously over the switch: Should she? Shouldn’t she? We will see very soon. It will be fireworks for someone, whatever happens.
Historical footnote: In truth even the idea in 1933 of a stable currency exchange supported by the dollar, even if based on gold, was never going to work. The US never forgave the war debts the UK had with her; and this meant the UK could not forgive the much lesser debts owed to her by the Allies, or go broke in doing so. Added to this Germany was not able to pay the ruinous reparations without destroying the very economy needed to pay those reparations. It was a mess that nonone was willing to resolve in the interest of the global situation. Politicians ran everything and economists just counted the disasters as they mounted. We don’t seem to have learned much since, either.