The Impending Interest Rate Disaster

InterestRateThis article is bred from an excellent article in Zero Hedge, dated Nov. 20, 2015, titled “What Will Happen to Corporate Profits if the Fed Hikes in December?”

I have argued that the Fed “can’t” raise interest rates. Then last week I suggested that the Fed may be forced to raise rates, given fraudulently low rates in an environment of growing hatred toward the U.S. for its effort to strip nations of their sovereignty and, like all empires, rule over the rest of the world. Why should China buy U.S. Treasuries when doing so is only supporting a hostile U.S. policy toward China in denying her the right to control her own sea lanes? So I argued that unless the Fed wants to continue to swell its own balance sheet and buy virtually all the U.S. Treasuries in the world, it may have to raise rates to entice foreigners to buy U.S. Treasuries.

I further suggested that with the oil price cut in half and with China now buying most of its oil from Russia and Iraq, not in exchange for dollars but for gold and currencies other than the dollar, there was less demand for the dollar and thus U.S. Treasuries, putting further pressure on the Fed to raise rates.

Then there is simply the issue of Fed credibility. Propaganda from earlier this week tried to convince Wall Street that the economy was strong and that that was the reason rates were being raised. That of course is not true, but any time a con artist can get away with a lie he/she will do so. All I can say is shame on a very gullible American public and Wall Street.

I have pointed out many examples of why you cannot make the case for a strong U.S. economy, but one more that may actually wake up Wall Street is an earnings recession that is clearly developing, as you can see from top chart above. The black line shows that outside of the financial sector, earnings have been falling dramatically all through this year. The red line represents earnings declines this year for the entire market. Earnings for energy and metals companies have been the hardest hit. But now take a look at the blue line, which takes out energy companies. Even when you exclude energy companies, earnings overall in the U.S. are now in decline and likely to record two successive quarterly declines. Thus an earnings recession is upon us now.

The Fed and government propaganda artists can fudge the numbers with psychological manipulation but they can’t change the dismal reality that at best we are experiencing nearly zero growth and most likely, if honest inflation accounting were employed, we would already be in an economic recession. Yet, unless something unforeseen happens, it seems that the Fed is making your editor into a liar. It seems as though the Fed is likely to raise rates by ¼ percent perhaps for all of the geopolitical and credibility reasons noted above.

Which brings me back to earnings and the other chart shown above, namely, the dollar. Although there is a lag of approximately one year, it should be rather easy to see a correlation between the dollar’s strength and a major decline in overall earnings of American corporations. This is true not only because of a decline in earnings from uncompetitive exports, but also, with a strong dollar, consumers can purchase imported goods more efficiently as well. Now, with most other regions of the world all engaged in massive QE and competitive devaluation of their currencies, a rate rise by the Fed now would only serve to cause the dollar to rise even further, leading to an even greater decline in profits. In short, with a strong dollar, the U.S. is importing deflation and in the process hurting corporate profits.

What might all this mean for stock prices? So far, U.S. stocks have increased their P/E multiples, thus maintaining stock prices near their highs. But how long can P/E ratios rise with plunging profits and rising interest rates? The Zero Hedge article suggests that even if we get record corporate buy backs, corporate profits should decline by at least 10% in 2016.

Also in that same article, Zero Hedge drew a comparison with the strong U.S. dollar now and the strong Japanese yen in the 1990s. The trade weighted dollar is already as high in 2015 as the yen was in the mid 1990s. When the yen rate rose that far out of sync, it choked off profits and led to “a lost generation.”

“Looking historically at rate rises in the U.S., the U.S. dollar has risen for about three months prior to the rate rise and then another 30 days afterwards But then the dollar weakens as the markets begin to realize that the Fed has sown the seeds of its own destruction and unleashes the very forces that will demand a rate cut in the not-too-distant future Actually, the bond market may be sending us a signal exactly along those lines. Long dated U.S. Treasury yields have fallen dramatically over the past few days as a rate rise now seems baked in the cake. If the economy were so strong and capable of observing a rate rise, why would the bond market be saying otherwise?”

And so I think I may still be proven right in my premise that the U.S. economy is not strong enough to absorb a rate hike. For reasons of credibility and/or funding U.S. debt from overseas savings, the Fed may feel coerced into raising rates. But with a stronger dollar hurting the U.S. economy by importing deflation and leading to reduced profits, I think the Fed’s rate rise, if it is to take place now, will backfire and lead to a reversal of policy and perhaps a very aggressive easing that may end up putting a nail in the coffin of the evil Federal Reserve Bank that has destroyed the American economy by disabling price discovery of capital.

The Zero Hedge article concluded as follows: “And certainly the Fed, because if what the Fed is about to engage in is a major policy error as the flattening yield curve suggests, with Yellen forced to promptly cut rates in 2016 and perhaps even go negative, that may be the last error the Fed, as a central bank with credibility among ‘serious economists,’ will ever make before it has no choice but to unleash the monetary helicopters.”

In other words, as we near the end of November 2015, we may indeed need to wait until the early days of 2016 for an aggressive easing and decline in value of the world’s reserve currency. How bad for gold could that be?

About Jay Taylor

Jay Taylor is editor of J Taylor's Gold, Energy & Tech Stocks newsletter. His interest in the role gold has played in U.S. monetary history led him to research gold and into analyzing and investing in junior gold shares. Currently he also hosts his own one-hour weekly radio show Turning Hard Times Into Good Times,” which features high profile guests who discuss leading economic issues of our day. The show also discusses investment opportunities primarily in the precious metals mining sector. He has been a guest on CNBC, Fox, Bloomberg and BNN and many mining conferences.