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The FED raises the interest rates.

 

 

By Alfonso Elizondo

 

On Wednesday September 16th, the US Federal Reserve (Fed) finally increased the interest rates, which had remained unchanged since 2006, from 0.25% to 0.50%. The financial authorities justified this by saying that the US economy is now strong enough to continue growing with less help from the Central Bank. So they have gradually increased the rates, since the costs of the public debt have started to rise quite quickly.

 

William Glaston, who was the financial advisor for Bill Clinton and now a senior executive of the Brooking Institution, declared that he felt very frustrated for not having created an infrastructure bank backed by the government in recent years. James W Paulsen of Wells Capital Management also said that the governmental spending for investments, compared with the general economic activity has fallen to low values that had not been seen since the 1940s.

 

Economic experts have found that many of the fights within the Government of the United States have reduced the flow of money meant for government projects to improve roads, bridges and public transit. Even the private sector didn’t witness the benefits expected from low cost loans when rates were very low for so many years.

 

The vast majority of companies have had access to billions of cheap dollars provided by the Fed, but haven’t used them to make new transactions that might have strengthened the recruiting of new employees and made American companies more efficient and competitive globally. Economists think that companies missed great opportunities of cheap money and it is very likely they will remain unused now that bank loans have become incredibly cheap due to the fact that millionaires have withdrawn from productive activity.

 

Although the stimulus policies of the Fed led banks and investors to lend money, raise stock prices and increase consumer confidence to achieve economy recovery, lower unemployment and boost sales in the real estate and automobile sector, analysts say that money wasn’t injected into where it is required in order to improve the country’s economic potential for the long term.

 

From a theoretical viewpoint low interest rates should have encouraged companies to borrow money to invest in new machines and technologies that could improve their profitability and make them more competitive in the global markets. However, industrial investment as a percentage of GDP has remained below historical lows reached during the Great Recession. Also surprising is the lack of investment towards borrowing policies of companies that issued junk bonds í in a market that collapsed after the Fed cut on the interest rates.

 

According to Merrill Lynch, from 2009 until September 2015, US companies that issued bonds only declared 2% of revenue coming from bonds as capital spending, therefore it is easy to conclude that most of the bonds issued were used to pay debts that had been contracted by companies and to finance acquisitions and purchases that had already been planned.

 

According to Michael Contopoulos, head of leveraged loan strategy for Bank of America Merrill Lynch that has been a big problem that still exists, since the lack of company’s investments may slow the future growth rate in the United States. It may have also reinforced productivity, a very clear economic criteria to measure how much an economy can produce with the resources of capital and labor at its disposal. So the deceleration of the US economy in recent years continues to create great preoccupation among American economists.

 

A paradoxical point of view is that of former Secretary of Treasure Lawrence H. Summers who referred to the experience of Japan, where interest rates have been very low for many years. Summers said that during a period of very low interest rates is very easy to roll over loans, because there is very little pressure to re-invest into inefficient firms or even the ones close to collapse.

 

With Fed raising the interest rates, this could start a period of agitation and instability for major US corporations. The recent turbulence related to junk bonds suggests that investors are waiting for bankruptcies, probably within the energy sector, and this would create long-term exchange rates that would make the economy stronger. But if banks and investors cut back on lending money, the economy may collapse.

 

Although it appears that interest rates will rise, some economists say this is not an optimistic alternative. They say that productivity was weak in the post-crisis years because high unemployment kept labor costs very low so that businesses could operate without incurring into a loss. According to Jared Bernstein, Financial Advisor of president Obama, while unemployment is not reduced, wages may increase, as companies facing higher labor costs will not have other choice but to invest to become more efficient.

 

If the economy continues to grow and fiscal pressures are reduced, the federal government, states and cities could spend more in infrastructure, even when faced with higher costs of debt. This month Congress approved a Transportation Act for 300 billion dollars to be used for roads and bridges, so that three of the most famous outstanding works in New York can be financed: the famous gateway to leave town which construction is already 100 m years old, new tunnels under the Hudson River and the ones damaged by Hurricane Sandy last year. With this new Transportation Act, the current situation could be improved without incurring into financial problems.

 

Addendum: As it’s easy to see at the moment, when those in power in the United States believe that the most critical time its financial crisis has finally passed and the economy of the great western will return to be the same as always, there is the doubt that while empowered elite of billionaires will continue to gain control, the United States are doomed to reach their decline as an economic power. Something similar to what happened with all empires of human civilization.