CPA Gone Mad Issue 2: December 12, 2016
Everyone expects the Fed to raise its key rate. Clearly this means the economy is improving, right?
The big financial news this week is surrounding Chairwoman Janet Yellen and whether the Federal Reserve will raise its key rate on December 14. It’s going to. Or at least that’s what everyone is saying. It’s really a nonevent.
Mainstream financial outlets will be listening to whether Yellen talks about increasing rates more often or faster in 2017. The last rate increase was one year ago, and expectations were for several increases in 2016. They didn’t come.
But now they’re going to raise rates and probably talk about more increases in the next year. So what does this mean for you?
Mainstream financial outlets will probably shout that this signals an improving economy. Unemployment is down. Trump’s economic plan is going to get economic growth. And we may even have some inflation. If the Fed is willing to raise interest rates, clearly this means the economy can handle it.
Not so fast. In my book, Gen X & Millennials: Protect your Money and Prosper, I discuss how lowering interest rates is one of the key weapons against a recession. And how the US is on the verge of a recession. Currently, the key interest rate is .25% to .5%. It’s practically zero. If the Fed raises interest rates on Wednesday, it will most likely be to only .5% or .75%. Still practically zero.
If we have a recession, rates are so low, the Fed could barely lower them. So the Fed may raise rates quickly in 2017, not because the economy is doing well but rather just to make them high enough to lower them when a recession comes.
How’s that for making sense? It doesn’t make sense. Raising rates just so you can lower them?
And here’s the thing: Raising rates could bring about a recession even more quickly.
In my book, I discuss how raising interest rates makes the dollar stronger. A strong dollar makes goods and services produced in the US more expensive than foreign goods. With worldwide GDP growth slowing, a stronger dollar is going to hurt the US economy.
On top of that, higher interest rates are going to make bond prices drop. Raising interest rates could trigger a complete bond collapse.
So don’t take the noise in mainstream finance at face value. Raising interest rates doesn’t directly mean anything in regard to how well the economy is doing. But it could cause the economy to do worse. And it could cause the bond market to begin collapsing.
Now, as I mentioned last week, certain things will do well. Although I believe the stock market is overvalued and a financial crisis is inevitable, the market will rise in the short term. Specifically, higher interest rates will help financial stocks.
But here at CPA Gone Mad, I don’t want to trade in and out of the market. I want to help you learn how to invest for the long term. And the key takeaway this week is to not let the noise of raising interest rates lull you into thinking the economy is improving. It could actually hurt the economy and drive us into recession more quickly. In fact, the Fed could be raising rates just to lower them when the recession comes.
In other news, on December 4 Italy voted down a referendum that basically forced its prime minister, Matteo Renzi, to resign. This referendum was not the same as the UK referendum back in June. That vote was specifically to decide whether the UK would leave the EU. The vote resulted in the ensuing “Brexit.”
This Italian referendum was not as direct. Renzi was a supporter of the EU and wanted to introduce reforms that gave him more power to make changes in Italy. The Italians voted against this. So while it may have signaled some dislike of the EU, it wasn’t directly a vote to leave the EU.
I’m not reading too much into this specific referendum. I’m paying attention to the Italian bank crisis and the impacts the referendum could have on that. As I mention in my book, Italian banks, including Italy’s oldest bank, are on the verge of failure. They are significantly undercapitalized.
If Italian banks were to fail, this referendum’s loss could cause the EU to not bailout the banks and instead require a “bail-in.” A bailout is where the EU will provide capital to create liquidity for the bank to continue operating. A bail-in is where depositors and bondholders pay to recapitalize the banks.
Should a bail-in occur, I don’t believe Italians will be happy. They could push for a specific referendum to leave the EU. If Italy were to leave the EU, the euro could collapse and almost certainly trigger a financial crisis.
The UK didn’t use the euro as its currency, so its leaving the EU didn’t create as much widespread currency issues. But Italy does use the euro. If it were to leave, the euro would be doomed.
I don’t know what’s going to happen next in Italy. The point of this is to make you aware of what’s going on in other parts of the world. And to help move your thinking away from the mainstream media’s political implications and into the real economic situations that could occur. And since the world is connected, a bank and currency crisis across the pond would surely come stateside.
To your health, wealth, and personal freedom,
Chad A. Walker, CPA, MBA