NEW YORK (TheStreet) -- The Federal Reserve is on track to raise interest rates later this year. Chair Janet Yellen has good reasons to push ahead, but she may not get very far in her quest to "normalize" rates.
Inflation is heating up.
Thanks to falling oil prices through January, consumer prices are down 0.2% from a year ago, but oil and retail gasoline prices have been surging recently. Core inflation, which excludes volatile energy and food prices, is quite close to the Fed's target of 2% and has been accelerating in recent months.
Investors are building a 2% inflation premium into the price of 10- and 20-year Treasury securities, and history teaches that inflation can fly out of control if the Fed does not act preemptively.
Rock-bottom short-term interest rates impose significant distortions on labor and asset markets. For example, elderly Americans rely on CDs to invest significant portions of retirement savings, but the 5-year rate on those is 1.45%, well below expected inflation, especially once taxes are considered. Consequently, larger numbers of Americans over 65 are working, crowding out young job seekers struggling to start careers.
Near-zero short-term borrowing rates for banks artificially lower risks on trading, deal making, and the financing of hedge funds and private equity plays, and distract banks from lending to young businesses with good ideas to grow the economy.
Cheap mortgages have pushed up residential real estate values to levels that discourage homeownership by young families. That's an important reason new-home construction has not recovered to its levels before the financial crisis.
The Fed has indicated it would like to slowly raise the overnight bank borrowing rate (federal funds rate) from 0.125% to 3.75%. By my estimates, that would imply a nominal 10-year Treasury rate of 4% to 5% -- or, adjusted for inflation, a real interest rate on productive business investments of 2% to 3%. That is simply not sustainable now or in the foreseeable future.
After a tough winter, economic growth should recover to 2.5% to 3% by the second half of this year, but only if the Fed does not push up interest rates too much.
Asian and European central banks are pursuing aggressive monetary policies aimed at weakening exchange rates for their currencies against the dollar and boosting exports at the expense of sales by U.S.-based businesses.
Significant increases in U.S. interest rates would strengthen the dollar further, and the resulting surge in imports and lost exports could easily slice one percentage point off U.S. growth and reduce job creation to perilously low levels.
Moreover, a real long-term interest rate of 2% to 3% is no longer sustainable, because digital technologies permit businesses to use capital so much more efficiently these days.