The Dollar: A Welcome Return to Orthodoxy

Free money is finished, at least in the United States. And good riddance. The U.S. Federal Reserve decided as of Wednesday, Dec. 16 to raise interest rates by a quarter of a point. From now on, American banks will be lending at a rate between 0.25 and 0.5 percent. This increase will be followed by other progressive increases in interest, probably one per quarter, probably a quarter of a point at a time. In three years, rates should have returned to normal — around 3.25 percent.

This move is historic in that the Fed passed it unanimously. It is also the first increase since the great crisis of 2008, which was revealed by the fall of the Lehman Brothers investment bank. At that time, the Fed had to deal with the greatest financial crisis that the world had seen since 1929, and maintain a world economy that was in critical condition: zero interest rates and almost limitless liquidity injected into the financial system — “quantitative easing” in financial jargon, “printing money” in layman’s terms. To date, the Fed has produced a mountain of debt: $4,500 billion.

These policies were necessary, but they have to come to an end. Free money is invested carelessly; it disorients investors and creates financial bubbles that can become very dangerous. Chairmen of the Fed at the time, Ben Bernanke, outlined the financial shift in the spring of 2013. But this provoked a panic in emerging markets, gorged on easy money and now in recession. As a result, the Fed had to act very slowly — too slowly — in order to avoid upsetting the financial markets. It gradually shut off the flow of capital during 2014. And finally, this Wednesday, it decided to raise interest rates.

The macroeconomic circumstances warrant it: The American rate of financial growth is decent, around 2.5 percent. The unemployment rate has been cut in half, and now only affects about 5 percent of the working population, although this is also explained by decreasing American participation in the workforce. Inflation is still too low, around 0.2 percent, far from the usual target of 2 percent set by central banks. But it should increase if energy prices stabilize and wages finally rise again.

Experience suggests that current changes could provoke a sharp rise in interest rates in the long term, and the consequences may not be felt for several years.

The Fed’s policy offers a striking contrast to that of the European Central Bank. The United States is returning to orthodoxy, while Europe has chosen to prolong its policy of quantitative easing until 2017, and impose negative interest rates on banks to force them to inject their funds into the economy. This difference is logical, given that Europe’s economy is less robust than that of the United States. In the short term, this move by the Fed should help Europe: rising rates overseas should weaken the euro, increasing inflation in Europe and reducing the ECB’s need to intervene. Nevertheless, euro countries will also have to get back on the path to orthodoxy if they don’t want to provoke another financial crisis.

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