Low Rates Are Correct. Stocks Are Too Risky


Yesterday’s Federal Reserve press conference by Chair Yellen made some commentators imply that she is unaware of the signs of improving employment and rising inflation. My response is that this recovery since the 2009 crash is very different and traditional metrics don’t apply very well. The traditional rule of thumb is that after a recovery if interest rates are kept too low then the economy overheats, creating too much demand for labor, which results in inflation from workers using paychecks to obtain loans, which causes the money supply to increase.

However since globalization began in earnest shortly after the 1990 recession we had only one shallow recession in 2001-02, so this recession and recovery is the first serious recession since the brave new world of globalization and deunionization made U.S. workers powerless to seek inflation causing pay raises. It is also the first serious recession since the debt monster escaped from the cage about 25 years ago. By this I mean the situation where the U.S. debt to GDP ratio is 345% versus a long term average of half of that. Additionally the rest of world is in a similar or worse debt situation, so we can’t get help from foreigners who might be able to create demand for our exports.

The hidden unemployed may be marginalized people who have minimal chance of reentering the workforce and thus are unable to help hold down inflation. But they are out there consuming, using borrowed money, student loans, overspending their retirement nest egg prematurely when they should be working, spending down house equity, being subsidized by their spouse, or gambling recklessly with speculative investments. These people will someday run out of resources and run out of consumer confidence. When they do then demand will be reduced, cooling down inflation, and reducing economic growth.


Hidden discouraged workers may not be an anti-inflationary force but new employees in a new career with low salaries may be a threat to the pay raise aspirations of better established workers. The harsh recession forced many people to start a new career. New people on a job are often an excellent source of reliable moderate cost employees through internal promotion. They are hungry to get better than a trainee’s wage, so if the experienced worker quits his job to seek a higher paying job the employers may be able to weather the storm without repeating traditional post-recovery patterns of bidding wars for employees. If inflation occurs through confident workers job hopping for a raise and then getting a bank loan, what if the quitters were easily replaced, without resorting to higher wages, by internal job candidates? This would suppress inflation more so than the hidden discouraged unemployed.

I disagree with Federal Reserve Doves who think low rates can create jobs. Businesses are suspicious of low interest rates and won’t be manipulated by the lure of low rates to commit to massive capital expansion projects and massive hiring, especially if the cheap money is a 30 day variable rate contract with no lifetime cap. Who would be dumb enough to borrow for a serious business purpose if they feel rates are artificially and temporarily low?


I don’t expect a suddenly loss of jobs or negative GDP, but I do expect a very weak global economy with Developed country GDP possibly averaging 1% and EM country GDP many not be much better if one assumes China’s data is either unreliable or is a temporary unsustainable debt bubble that could backfire and make things worse.

The combination of low growth rates and too much debt means that the world’s ability to earn and to consume is inhibited for the long term, thus implying that low interest rates are legitimate.


Future of labor force maybe deflationary or disinflationary where automation and complexity reward the talented few such as engineers and managers and punish the simple skilled masses who can be replaced thus forcing down wages for the bottom 80%. That is similar to the deflationary prosperity of the 19th Century where there were frequent deep recessions lasting 15 years. The popular myth is that Central Banks learned, after or during the 1930’s depression, how to prevent long recessions and that since the 1940’s we are in a permanent plateau of prosperity. Instead the long era of moderation and prosperity from 1945-2008 was due to the spoils of WWII and the end of the Cold War. The business cycle had not been eliminated by the Federal Reserve. The fact is the Fed’s rate cuts especially QE didn’t prevent the economy from experiencing a long term output gap or opportunity cost over the past six years. The Fed didn’t fix the problem of hidden long term unemployment. Much of the improvement in unemployment since 2009 was due to the 3% reduction in the labor force participation rate. It dropped from 62% to 59% which is actually 5% of the work force (but 3% of the population) if those people were still counted then the unemployment rate would be around 9.5% or 9.8% about the same as the crash of 2009. Corporate sales have not improved in several years. Corporate profits improved due to unsustainable costs cutting enabled by the recession.

  The solution to unemployment is to require people to take subsidized training for new careers to relocate to new employment.

The key idea for investors is to think contrarian and don’t assume traditional patterns of recoveries will apply to this one. Eventually after a time period like the 15 year long 19th century crashes the workers will have learned new skills, gotten fully trained, gotten motivated to move to a new area and those that haven’t may have become too old to remain in the work force. Then the economy will be a fully normal full employment economy with the traditional risks of a post-recovery period of wage-induced inflation. I mentioned recently that high unemployment will not be solved until 2018 but that was a simple linear projection; yesterday Yellen pointed out that the supply of people withdrawing from the work force may be all used up, which would make it harder to reduce unemployment, assuming that net new jobs created are 150,000 a month net of population increase, which is 1.28% a year reduction in unemployment. Assuming the U-6 rate of 12% is used then to get down to a reasonable level of unemployment would take 5 years by 2019 since full employment using U-6 is roughly around 6%.

Investors need independent financial advice about inflation hysteria and bond market and stock market risks. I wrote an article “Fed press conference deflationary clues”.



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About the author

Don Martin, CFP®

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