We are in very uncertain times. And they are becoming more uncertain. The Federal Reserve Bank(FRB) just raised interest rates .25% and has stated it is their objective to raise rates perhaps 3 times in 2017, in an effort to effectively curb inflation.
And while that may seem to make sense based on the way both the FRB has worked in the past, and what we have been told about inflation and how it works, these actions, perversely, are going to have the opposite effect this time around. Should I be correct, then the raising rates will actually fuel inflation, which will force more rate hikes, and then even more inflation.
Think about the reasons the FRB cut rates, and cut them so low, and then held them there for an unprecedented amount of time.
Consumer incomes took a big hit in the recession. People lost their homes, and their largest assets. Business profits crashed and companies were cutting payrolls in order to survive.
The rate cuts helped businesses that were credit worthy to refinance their debts at lower rates, which translated into higher profits. It allowed local and state governments to do the same, which put off tax increases, and left consumers with more income in their pockets. It also allowed companies to go on a borrowing binge, buy back more than 11 billion shares for the Dow 30 alone, creating a sense that earnings were awesome because per share earnings were on the rise.
Homeowners that could also refinanced, extending their loans to a new 15 or thirty year time frame, and lowered their borrowing costs, saving them money.
Here we are, nearly ten years later, and the FRB has decided that NOW is the time to start raising rates once more. They have injected trillions of dollars through Quantitative Easy (QE) and the low interest rates were meant to fuel this economy out of the recession.
The FRB sees that we have a strong jobs market and hiring has been steady since the start of 2016. Yet at the same time, we have a slowing rate of job growth year over year within the United States.
- 2011 174,000 jobs per month
- 2012 205,000 jobs per month
- 2013 193,000 jobs per month
- 2014 251,000 jobs per month
- 2015 229,000 jobs per month
- 2016 181,000 jobs per month
The number of workers in the US is up since 2011. Therefore the percentage growth in jobs year over year has fallen even since 2011.
How does the FRB then conclude that our job markets are strong and strengthening? Especially when wages are stagnant and the number of people not in the work force is the highest level we have seen since the 1970’s?
Profits are needed to grow an economy. Real profits. As mentioned before, the interest rate cuts allowed businesses to take actions that would enhance their profits. The FRB has stated that we have an economy that is growing solidly. But if that is true, shouldn’t the money earned by the economy actually reflect this? What does it say if GDP is rising but profits both before and after taxes are falling?
Let’s look at the total dollars in profit that have been earned by the 30 companies that make up the Dow Jones Industrial Average, which as been racing to the 20,000 level.
Dow 30 Profit Picture
- 2011 17.36%
- 2012 7.73%
- 2013 -1.67%
- 2014 2.78%
- 2015 -6.68%
- 2016 -5.53%
So, even with “historically” low interest rates and businesses buying back shares and taking on billions in new debt, this has not actually translated into greater profitability for these companies.
Of course that can be considered a narrow view of the economy, so we will expand it to cover the entire economy. And we will do that both before and after taxes for both corporations and proprietor’s of smaller businesses. Surely that must show that this economy is firing on all cylinders?
Corporate and Proprietor’s Income
Corporate Income Proprietor’s Income
Before Taxes After Taxes
- 2011 4.05% 4.48% 12.88%
- 2012 9.99% 4.78% 7.23%
- 2013 1.74% 0.31% 3.49%
- 2014 5.86% 0.10% 4.13%
- 2015 -2.97% -9.22% 2.92%
- 2016 -4.93% -7.48% 2.99%
These rates of growth or contraction from the previous year (as measured in dollars) does not paint the picture of a robust economy. Truthfully, they appear to paint the picture of a stalled out economy.
What exactly does the FRB think will happen to the profitability of American businesses as the cost of money rises? If these businesses are struggling to ear profits today, how will they fare as the cost of their borrowing rises?
Were US businesses believing that they were able to actually pass on price increases, it’s my belief that they would have already done so. But sooner or later, they will be forced to raise prices and see what happens. This will fuel the inflation fire.
And what will this FRB do when it sees the inflation numbers above their 2% target?
Raise rates again.
And so it begins.