The Federal Reserve is about to kick off another round of “follow the leader” with other central banks across the planet. Long the scourge of many a libertarian, the Fed once again betrays the amount of immense influence it holds over global geopolitics. After announcing a rate hike (only the third in a decade), economists and experts are speculating that the Fed’s counterparts in other nations will soon be forced to follow suit, according to Reuters.
One could be forgiven for eschewing economics in favor of the latest bit of intrigue to seep out of the White House, but to ignore the Fed is to ignore the man (or in this case, the woman), behind the curtain. Monetary junkies will be quick to point out that the Federal Reserve is neither a bank nor part of the federal government. And yet, the official website is hosted on a .gov domain, while the “System” (official name, not a jab) holds more federal debt on its balance sheet than every single U.S. bank, mutual fund, and savings bond combined.
So, when this lumbering behemoth of a cartel makes a policy change, the ears of the world perk up. The relationship between the federal fund’s rate and global economics is complicated, complex, and likely quite boring to most readers. But boiled down to its essence, the Fed rate hike means two things.
First, the cost of debt will rise. This rewards savers, but punishes borrowers. Anyone who has been paying even the tiniest bit of attention over the years knows that the United States government is a huge borrower. Look for interest on the debt to be a sneaky yet steadily rising component of the total overall budget. President Trump’s new budget, released just a few days ago, does not even touch the subject, instead focusing exclusively on discretionary spending. At $1.065 trillion, the discretionary spending sum is nothing to scoff at. However, in 2016 the U.S. spent almost $215 billion on interest payments on the debt – equal to over 20% of the total discretionary budget. Even a quarter of a percentage point increase in interest payments would amount to over $500 million dollars, enough to fund the entire General Services Administration.
Second, the dollar will strengthen. Because savers are getting a better return on their investments, consumers and business tend to save more and spend less. This helps to hold down inflation. Additionally, U.S. debt becomes more attractive since it now pays higher returns. All of these inputs combine to cause the value of the U.S. currency to strengthen. This rewards importers who can now get more foreign goods for the same price, but hurts exporters who must now charge more overseas thanks to a less favorable exchange rate. This could cause the trade deficit, one of President Trump’s favorite statistics to hold up as an example of American decline, to worsen even further.
As foreign banks chase the Fed rate back up to normal levels, look for increasing instability in weaker economies. Once other banks move, the domestic consequences of the Fed’s hike may be negated. This tug of war back and forth may only add to the uncertainty, so look for the price of gold and other safe haven assets to rise this year.
It will be interesting to see how President Trump fares facing the headwinds of a tightening Federal Reserve. Eight years into the recovery from the worst recession in half a century, a return to traditional rate levels is far overdue. President Obama only experienced two rate hikes during his entire tenure in the White House, with one of them as a lame duck. Though the timing of the latest hikes may raise eyebrows among the more conspiracy-minded, from the looks of the recent jobs reports and stock market highs, it seems that the president may not have to worry too much about Mrs. Yellen after all.