The Fed's Interest Rate Games
Valentin KATASONOV | 23.06.2016 | WORLD / Americas

The Fed's Interest Rate Games

Since the global financial system is based on the US dollar, the world’s attention is fixed on the interest rates of the Federal Reserve System. The Fed base rate, which is the same as the rate on Federal funds, is determined at meetings of the Federal Open Market Committee of the US Federal Reserve. There are eight of these meetings throughout the year, but the committee can also hold unscheduled meetings to change the rate. 

In the history of the FRS, the base rate has varied widely. The highest rate was recorded in 1980-1981, when the FRS was headed by Paul Volcker, and America began to adopt Reaganomics. Then the rate rose to 20 percent. In the 2000s, after 17 consecutive increases (in just two years), the rate reached 5.25 percent in June 2006. But even this rate, which is relatively high by US standards, was unable to prevent the US subprime mortgage crisis that then triggered the global financial crisis. The FRS began to drastically reduce the rate in order to slow the development of the crisis and then mitigate its effects. In two and a half years, by December 2008, the rate had dropped to a level in the range of 0 to 0.25 percent. 

In December 2015, the FRS raised the rate for the first time in seven years by a quarter of a percentage mark. Many in America saw this as a sign that the economy had overcome the crisis and was back on a growth trajectory. Commenting on this decision, the Chair of the Board of Governors of the Federal Reserve System, Janet Yellen, along with other members of the Board and the heads of 12 Federal Reserve banks stated that the FRS would continue its interest rate hike policy, raising it to the level of around 3.0-3.5 percent in two years.

At the end of April, the FRS promised that an interest rate hike would be made at the committee meeting on 14-15 June, but this did not happen. The next FRS meeting is scheduled to take place on 26-27 July. Experts say that the probability of an increase at this meeting remains low. It is expected that the rate will be frozen. There have even been assessments predicting that the US FRS will lower the rate to its initial value of 0-0.25 percent.

The central banks in a number of countries are closely following the FRS’s interest rate decisions and trying to make decisions that will be able to neutralise the effects of the Federal Reserve’s policy.

In order to counteract the FRS’s interest rate hikes, the monetary authorities of other countries usually increase their own interest rates simultaneously. This measure by no means always works, however. The People’s Bank of China has stated that if the FRS increases its base rate, then it, conversely, will reduce its interest rate in the hope that this will lower the yuan’s exchange rate against the dollar, stimulate its exports and thus compensate for any possible losses.

The Fed’s interest rate has become the subject of a fierce political struggle. The heads of states, governments, finance ministries and the central banks of many countries are against an increase. The fact is that an increase will turn America into a magnet that will pull in capital from all over the world. Last year, Janet Yellen repeatedly declared that an increase was possible and these verbal interventions proved to be enough for capital to start leaving China, India and other countries. A comprehensive turnaround of global financial flows began. 

In 2014-2015, there was a fall in the national currency exchange rates of countries on the periphery of global capitalism, this fall sometimes taking the form of sudden landslides. In addition, Washington hypocritically accused these countries of unleashing currency wars or organising currency dumping and these accusations, in turn, became the grounds for Washington to introduce restrictions and sanctions against countries that were already suffering as a result of the Fed’s interest rate policy. 

The executive director of the IMF, Christine Lagarde, was also against, and continues to speak out against, the Fed’s interest rate hikes. Lagarde believes that an increase could trigger a second wave of the global financial crisis.

In August 2015, at the beginning of the presidential race, Trump stated that as a businessman, he obviously loves low interest rates since they allow for cheap financing and ensure a growth in assets. As the possible future president, however, he is concerned about the Fed’s policy of supporting low and even zero interest rates for many years. According to Trump, zero interest rates are helping to create a bubble. And even though Trump has an impressive portfolio, the value of which is growing thanks to the Fed’s policy of ‘cheap’ money, he believes that the policy is dangerous.

At the same time, Trump understands perfectly well that a rise in interest rates will increase government spending on US sovereign debt servicing. Since the 2008 financial crisis, the US official public debt has almost doubled. According to the US Ministry of Finance, as of 4 May 2016, public debt had reached $19.2 trillion compared with $10 trillion in 2008. At the present time, interest payments account for the relatively modest sum of $250 billion of the federal budget (estimate for 2016). With much higher interest rates, this could double for starters. According to the official estimates of the US Congressional Budget Office, interest rates on 10-year Treasuries will exceed 4 percent in 2019 (compared with the current values of 1.76 percent). According to unofficial estimates, the interest rates on Treasury securities could triple. Interest expenditure could become the biggest share of the federal budget, even bigger than defence spending. Over time, the lion’s share of taxes may just be used to service debt. 

In an interview on CNBC at the beginning of May, Donald Trump publicly declared that America is heading towards a default on its sovereign debt: «We have $19 trillion of debt. We’re paying a very low interest rate. What happens if that interest rate goes up 2, 3, 4 points? We don’t have a country». 

For all the surface radicalism of Trump’s statements on financial matters, he can change his position quickly. While in August 2015 he said it was necessary for the FRS to raise interest rates, in May 2016 he said the opposite. 

Critics of the billionaire argue that contradictory statements like these show that Donald Trump lacks a clear understanding of how to lead America out of its current financial and economic impasse. In all fairness, however, it should be said that Hillary Clinton, who has been too afraid to even touch on the thorny subject of the Fed’s interest rate policy, has even less of an understanding.