They Wouldn’t, Would They?

They Wouldn’t, Would They?

On Tuesday and Wednesday officials from the Federal Open Market Committee (FOMC) meet to assess the state of the U.S. economy and make a decision about interest rates. Trying to muddle through the Fed-speak of previous announcements, most observers are confident that the Fed will pass on an interest rate hike, which would be the smart thing to do in view of both the markets and central bank actions in other major world economies.

Despite the relative certainty that the Federal Reserve is going to do the right thing and leave interest rates where they are, there’s still that nagging feeling that stems from the knowledge that central banks, including our own, are not run by sane people. At the very least, they’re not run by people who have the same needs and motives as we do.

While the nature of the Fed’s conflict is understandable, the path they’ll choose is unfortunately not at all clear. There’s general agreement from almost everyone in business and economic academia that interest rates have been too low for too long. But instead of raising rates during the recovery years of 2012 and 2013, the Fed hesitated. Sure, they talked about raising interest rates in those days, but even when the economy was red-hot, the Fed was still dumping money into our financial system with a program called Operation Twist. Just at the time the Fed should have been raising interest rates it was doing just the opposite.

The Moment Passed Us By

Back in 2012 the Fed was reassuring investors that the low-interest-rate good times would last until at least 2014. A lot happened in the global economy between 2012 and 2014, including the steady rise of the dollar. Normally, when a central bank is dumping money into the economy it dilutes the value of its currency and spurs inflation. But other countries were doing what the Fed was doing except on a bigger scale, which meant the U.S. dollar actually attracted even more money. Between 2012 and 2014 the dollar soared to record highs against other currencies and, of course, that’s when the Fed started saying it was really going to raise interest rates.

Zigging While the Rest of the World Zags

Of course, the rate hike finally did come, right when central banks in Europe, China and Japan were doing just the opposite: shoveling ever more money into their flagging economies and doing everything possible to dilute the value of their currencies. The U.S. stood alone against the tide of money printing and the dollar soared, in the process taking down commodity prices, especially oil. So we find ourselves in the position of being the one nation today with a central bank trying to do what would have been the right thing in 2012—but at a time when that action no longer fits the financial landscape. It doesn’t make sense for the Fed to raise rates now, that’s precisely why we have to be prepared for them to do it.

So the financial world now awaits the Fed’s decision, which will be announced later today. Most people think they’ll make the right move, but there’s enough nagging doubt that we’re not dealing with rational people that stock market indexes could experience some serious volatility. If the Fed comes through with a surprise rate hike, we can kiss the meager recovery our 401(k) balances made in March goodbye. A surprise hike would be like setting the stock market on fire and burning it down.

What They Want vs. What You Need

There are two facts to keep in mind while watching this drama play out: One is that the institutions that manage the world’s money supply are run by very rich people who are in many ways insulated from the consequences of their actions.  This is, to them, something of a theoretical game.  If stocks tank, or people get laid off, that’s just data for their charts and graphs.  They won’t lose their jobs.  They won’t have their retirements wiped out just as they were exiting the workforce.

The other fact to remember is the global race to the bottom on currency valuations is not going to end anytime soon. It’s become entirely apparent that sane, conservative investors will look for ways to hedge the value of the cash they have in the bank. Chinese investors have a lot more experience with a weak currency and have shifted to the safety of liquid hard assets.

Following their lead by hedging the value of your cash, maintaining a defensive allotment in your equity asset distribution and stashing away some gold are wise moves in a crazy financial world.