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Alain Boublil Blog


When the FED procrastinates

Why put off something to the next day when you can do it the day after the next day, said, with humor, Mark Twain. This joke sums up perfectly the non-decision by the FED regarding interests rates in the U.S. Explanations are not convincing. China has a broad back. An interest rate increase in the U.S, regarded until the meeting as sure, would have generated a rise of the dollar, followed by the Yuan since the two currencies were linked by a fixed parity. This is why Chinese authorities, indeed at the worst time, had decided to reform currency policy, decision which was followed by a “devaluation” of the Yuan, of less than 3%.

The truth is that there is definitely no reason to increase interest rates in the U.S. and, obviously, in Europe. FED mandate scope, larger than the ECB one, is about price stability and employment. The first is satisfied since the last inflation figures show a price increase of 0,3% during the previous twelve months. But the second criteria is far from being fulfilled since, if unemployment rate is at a the very low level of 5,1%, it is because tens of millions of Americans have renounced to look for jobs and have disappeared from statistics. The activity rate, less than 63%, is at its lowest level since the 70s. Difficult to see how an interest rate rise could contribute to the realization of the first objective since it is already fulfilled and of the second, since the slowing of the economy which would result from it, would, at the opposite, be an obstacle to job creations.

Behind these contradictions, there is a confuse feeling that so low interest rates reflect an abnormal situation which should be corrected. This is a wrong analysis. Very low interest rates, we observe for long maturities, result from market conditions. In Europe, for instance, savings are, by far, enough to satisfy financial needs of issuers, sovereign states in first. And there are no reasons to believe it is going to change in the coming years.

The other mistake is about monetary policy purpose. When demand exceeds supply and generates tensions on prices and salaries, interest rates rises contribute to slow it in making investment financing more costly as borrowing for households. They encourage them to save, instead of spend.  Conversely, but with lower efficiency, interest rates reduction may stimulate demand to generate a new growth cycle. They were economic policy tools used in the past, by central banks, with or without the agreement of governments, depending of the degree of their independency. Interest rates handling was used also to cope with currency crisis. They were increased, in case of excessive external deficit in a country, to support its currency.

In developed countries, these considerations have become largely obsolete. Cumulated effects of productivity gains permitted by innovation in industries and in services, and of international competition generated by globalization, were enough, without any monetary intervention, to contain inflation. And if we add the fact that these innovations contributed  to increase the supply of raw materials and to reduce transport costs, we have to note that we are facing such a new situation, that, through a cunning semantic manipulation, we now adopt price increase target, instead of price stability. To eliminate inflationist habits which had affected Europe between 1975 and 1995, a strict mandate was given to the ECB but with a smooth definition of price stability, under but close to 2%. It was to calm down hawks, located frequently on the other side of the German border, who could have been tempted to adopt a 0% inflation target and to set even more restrictive policies. The turnaround consists now to adopt policies to lift prices to a 2% target.

But monetary policy will not, by itself, make this turnaround possible. The paradox lies in the fact that we have never attached such an importance to central banks than now, but problems developed economies are facing are not any more in their scope of intervention. Their decisions have, today, much more influence on the value of assets than on real economy, as   the fall of Paris stock market shows, the day after FED decided not to decide. So developed world must be prepared to a much longer period with very low or even zero interest rates.  

What are the consequences for the most indebted countries, and France is one of them? These are excellent news, if authorities know how to take advantage of the situation, and don’t fall in denial (it is not going to last…) or in concealing the effects. The fall of the cost of public debt will be spectacular. The Finance Act for 2015 and the Planning Act for 2015, 2016 and 2017 were forecasting public debt costs of 44,3, 47,7 and 50,1 billion euros. Real cost for 2015 will be around 42 billion and cost will remain stable for 2016 and 2017. It represents, for these three years, a reduction of public expenditures of more than 15 billion. But the impact of the fall of interest rates, since they are issued with fixed interest, will last all along the duration of the bonds. For example, France will reimburse next October a 27 billions bond, with a 3% interest rate. Annual interests paid were 810 millions. As France issues since the beginning of the year, bonds with an average interest rate of 0,6%,  the cost of the new bonds replacing the former 3% one will be divided by five. France will save each year 600 millions, just by replacing a former bond arrived at maturity by new emissions. And the saving will become more and more substantial as new emissions will replace former ones with high interest rates.

France must accept and learn to take advantage of this unprecedented situation. First precaution, transparency. This windfall profit, for public finance, must not be used to hide the failed attempts to limit public expenditures. Government must confirm the policy, reduce unproductive public expenditures and use these new margins of maneuvers generated by the fall of interest rates to stimulate activity.To talk about growth with a rate of 1 or 1,4% is an abuse of the language. Second recommendation, to limit as possible, bond issues with an interest rate superior to market rate which permit to pocket  premiums which do not enter in the calculation of the budget deficit but which slow the reduction, in the future, of the cost of public debt. They represent, since the beginning of this year close to 10 billions. Third recommendation, to stop this policy which consists in selling off shares of companies where the state is a shareholder with dividends representing 4 to 5% of the value of the share, and sometimes even more, to reduce public debt when refinancing costs are, as an average, ten times lower. It is self-spoliation.

Very low interest rates are here for last a long period of time. FED analysis is unequivocal. And ECB is on an even clearer line. Sovereign states, and France in particular, must understand that they will be the most important benefactors. It is their responsibility to find the ways, without procrastination, to transfer the benefices of this new situation to their economies, to break old theories and to generate a new growth cycle.



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