The Federal Reserve did not raise interest rates last month as many expected. Their reasons were understandable: one in 10 Americans remains unemployed, underemployed or so discouraged that they have fallen out of the labor force; inflation remains consistently near zero; and growth remains below three percent with large swings from quarter to quarter. Those domestic issues are reason enough for holding off on raising rates. But over the last two years, another reason has emerged. Even as global growth has slowed, foreign governments have devalued currencies to make their products more competitive on global markets. There is now an ongoing global competition to generate jobs through export-led growth.
How does this work? Let me explain in concrete terms. In the summer of 2008, if you were a tourist shopping in Rome, you would have paid $1.60 for every euro. If you wanted to buy a suit worth 500 euros while there, you would have paid $800. Today, given near zero inflation in Europe over that time, at today's exchange rate of $1.12, you would pay $560 for that suit. In 2008, you might have held off and bought that suit back home in Chicago from an American retailer and maybe even an American maker; today buying that suit in Europe is a bargain. Not many Americans travel to Rome to buy suits, so I'll bring the example home. When you go to the store and compare the price of an item made in a Eurozone country today versus the price of that same good made in America, that European-made good is now 30 percent less expensive than it would have been before the Great Recession, because of the dollar's strength relative to the euro.
The Chinese are embarked in the same competition. Growth in China has slowed as export demand has weakened due to slow the global growth, their own domestic production costs have risen making their products less competitive, and local consumer demand has been slow to materialize. The government's reaction, as in Europe, has been to devalue the currency, in this case from and already weak 6.1 yuan per dollar to 6.4. Around the world the trend is the same: Over the last year, the Brazilian real has fallen from 2.4 to the dollar to 3.9, the Russian ruble from 50 to 73; the yen from 99 to 134 over three years. These are vast changes over short periods of time and make U.S. goods more expensive overseas and overseas goods less expensive in the United States. To again make these changes tangible, a 24 real undershirt that cost $10 in Brazil two years ago now costs $6.15. Imagine if you were manufacturing $10 t-shirts in the United States and were told that your Brazilian competitor just cut his price by $3.85.
This cycle of devaluation is self-reinforcing. Investors, seeking currency gains, begin to move euro-denominated funds into dollar accounts, creating added demand for dollars, further driving up the dollar's value. Normally this cycle resolves itself as countries take coordinated action to strengthen their currencies relative to the dollar, typically raising interest rates to attract demand for their currencies in global markets or even intervening in markets by purchasing their own currency to create demand for it. But these aren't normal times. Global growth, 5.4 percent per annum in 2011 coming out of the global recession, has been slowing down and is projected below three percent for a second year in a row in 2015, leading governments to look everywhere they can for growth. The facts are simple. Growth in Europe is at a near standstill. In China, growth has slowed to the lowest rates in more than a generation. In the United States, growth has been sluggish, averaging 2.5 percent. The three largest economic zones in the world, Europe, the U.S. and China, are seeing slowing or no growth. That slow growth in the leading economies is contagious. Those large economies do not exist in a vacuum, their industrial production is fed by a vast network of inputs, many from developing countries. In Nigeria, where the primary export is petroleum, GDP growth is down to two percent, the lowest in a decade. Chile, where copper prices have fallen precipitously, growth has fallen from nearly 10 percent in 2011 to below two percent in the most recent quarters. Brazil, growing at over seven percent just a few years ago, has seen its economic growth turn negative this year.
There is simply a lack of demand in the world right now. Plunging commodity prices, inflation near zero in Europe, Japan and the United States, and low GDP growth all speak to that weakness. Oil prices have fallen from a peak of $145 a barrel in 2008 and $100 in 2011 to $45 today. Copper prices have fallen from $4.50 per pound in 2011 to under $2.35 today. The value of these primary inputs and others has fallen at unprecedented speed over the last 24 months. In the face of those challenges countries are attempting to pull in demand from trading partners by devaluing their currencies, making their goods cheaper to purchase in the United States.
This is not an esoteric economic issue. It is an issue that is being felt in the day-to-day lives of Americans. For the last five years, the U.S. economy had been generating jobs steadily at over 200,000 a month, reflecting growing economic strength. But the data just released on Friday showed the economy generating an anemic 142,000 jobs, and the already weak August report, which showed 173,000 jobs created, was revised down to an even worse 136,000. Prior year totals were also revised downward by over another 200,000 jobs.
Which brings us back to the Federal Reserve. Faced with inconsistent growth below two percent, inflation well below its two percent target, job creation feeble and falling, and the dollar strengthening precipitously, the Fed decided to hold interest rates at effectively zero. But what choice did it have? Raising interest rates for dollar denominated assets would have increased demand for dollars and driven the dollar's value even higher. The stronger dollar would have shifted more domestic demand toward imported goods and made our export products more expensive overseas. The impact of any rate hike in this economic environment will be magnified, both its domestic and global implications need to be understood.
The Federal Reserve is in an unenviable position. Janet Yellen has all but announced a rate increase before year-end, but what will have changed between today and 90 days from now? Will any of the domestic and international factors at play have changed by the end of the year? Unlikely.
We are now nearly eight years removed from the collapse of Bear Stearns and the siren call of the Great Recession. Yet we remain in a low growth, low employment environment, in which domestic policy makers, having shed the extraordinary budget deficits and ended Quantitative easing, are still unable to restore normalized interest rates. It will take courage for the Fed to make the decision to normalize in the face of the slow growth domestically, the aggressive devaluation of competing currencies and no hint of inflation.
The rate hike, justified or not, may come this year, but it should be nominal and further hikes muted and slow-to-come unless economic conditions improve not just in United States but globally.