Federal Reserve pronouncements are always confusing

On Sept. 17, the Federal Reserve’s Open Market Committee meeting concluded that the economy is expanding slowly, so interest rates will remain low. That is what the stock market wanted to hear, but what was really said was that the economy won’t get better until Congress acts and the Fed’s ability to be effective is nearing its end.

The announcements coming from the Federal Reserve are all important to business and markets around the world. As America’s central bank and the keeper of the currency, virtually all markets have to pay attention. The dollar is the reserve currency in the world, which means, quite simply, that almost all goods and services are ultimately quoted in and transacted in dollars.

{mosads}Part of the press release did address the real concern. “Fiscal policy is restraining economic growth, although the extent of restraint is diminishing.” That is just “eco-speak,” meaning Congress has done little or nothing to help spur the economy. It is true that there was a stimulus package constructed in 2009 and it is also true that the massive bailout of financial institutions virtually flooded the markets with dollars. The problem now is that flooding the system with liquidity and holding interest rates down only cured part of the problem.

The Federal Reserve cannot dictate where its monetary policy deposits the money it creates. It sets reserve requirements for banks but does not make loans to customers. The theory is that cheap money makes it attractive for business to borrow, wealthy investors to become “job creators” and liquidity to reduce fears about solvency. The markets have rallied over that past four years and investors have done well. It has been stated, however, that over 90 percent of the growth in the economy from 2009 to 2014 has only benefited the 1 percent.

So the unspoken or vaguely referenced point in the Federal Reserve press release is that the money it supplied simply went to the wrong people. The job creators have been reluctant to invest in new jobs. They have simply used their wealth to chase stock prices. While that, in itself, sows the seeds for a significant “market correction,” the immediate problem is that American workers have received no real increase in wages. Because there has been no increase in wages, consumer demand has been sluggish. Since consumers represent 70 percent of the gross domestic product, or total transactions of goods and services in a given year, sluggish consumer demand is a concern.

People who watch the Fed and look at the data that the Fed generates should be alarmed. The velocity of money through the economy has dropped sharply since the onset of the recession. Money in this case is referred to as “M1,” which is currency in circulation plus money in banking accounts. What does that mean? It means the number of times all of the money in the system turns over (or is spent) in a given year is a strong indicator of the health and strength of the economy. If you liken it to your household budget where you spent your M1 (paycheck and checking account balances) in the month you received it, the velocity of your personal money supply would be 12 times a year. While that might be a little frightening for you, it is good for the economy. When the velocity of the money supply is high, it means the economy is cranking and healthy; when it declines, the economy stagnates.

In 2007, before people were scrambling to keep their households intact, the velocity of M1 was 10.3 times a year. It is forecast to be 6.2 times once we end 2014. You might argue that this slowdown is not necessarily a bad thing, because it could be construed that Americans are being more prudent and are holding on to money longer. But it can also mean that the wrong people have the money, since most average wage earners are living from paycheck to paycheck. It could be said that the slowdown provides plenty of firepower for consumer spending as confidence grows. However, if all the economic gains of the past five years have gone to less than 1.5 million Americans, how much are they going to spend? They already have everything they need.

This notion that the wrong people have the money is corroborated by the amount of money invested in stock markets and other financial instruments and by corporate resistance to investments in plants, equipment and new employment. The popular meme from the right is that U.S. corporate tax rates are “too high; they are the highest in the world” and this inhibits investment. This is not really an effective argument when you realize that the nominal tax rate of 35 percent to which they are objecting has little or nothing to do with the effective rate, which is estimated to be 9 percent. Anyone who has been in business knows that tax rates are a marginal issue when it comes to new investment. The real reasons are more likely that they can put off investments by manipulating work rules, curtailing vacation time, requiring overtime, offloading jobs to part-time status and suppressing wages to keep margins high while very slowly responding to sluggish demand. Since most of their money is made “riding their stock positions,” there is little incentive to do the “job creation” thing.

All of which brings us back to fiscal policy. More government investment in infrastructure and education would result in increased demand. Passing a higher minimum wage would result in increased demand. Equal pay for women would result in increased demand. Making employers pay full benefits and restricting their use of part-time or contract employees would result in increased demand. Tying executive pay to average employee pay would increase demand. Linking productivity increases to wage increases would increase demand.

The American fiscal house is in a state of disorder, ranging from the inequities of corporate tax contributions to the exploitation of workers. It is simply astounding that the level of political indifference has been permitted to go on for as long as it has. The Federal Reserve press release phrased it politely, but its efforts are beginning to appear to have run their course. What happens next is much like what happened after the Depression — it took a war to bail us out.

Russell is managing director of Cove Hill Advisory Services.