The ISM June service sector report came in as expected at 56.0, and that is consistent with a continuation of moderate growth in the biggest sector of the U.S. economy. Meanwhile, a similar report for the Eurozone shows conditions have been slowly improving for the past two years. We're still in a slow-growth economy, but nevertheless it continues to grow and conditions continue to improve.
We've had six years of this, and with each passing month the rationale for zero short-term interest rates weakens. Years of near-zero interest rates are now the unique feature of the current business cycle expansion, but the reason for low interest rates is widely and commonly misunderstood. I think it's because central banks have conditioned global financial markets to view extremely low interest rates as "stimulative." Central banks want people to believe they are keeping rates low in order to "stimulate" economic growth. But despite trying really hard for many years to pump up growth, they but don't appear to have been very successful, because growth remains rather tepid. Is that because they haven't tried hard enough, or is there some other reason?
I've argued for many years that zero interest rates are symptomatic of a market that is risk averse. Interest rates on short-term, safe assets are low because the demand for them is very strong. Central banks have been obliged to accommodate this demand for safety by supplying tons of bank reserves. They've set interest rates low because that's where the market has driven them. They haven't been stimulative at all; you can see that by the fact that inflation remains very low. And of course, the premise that central banks can stimulate growth is highly questionable to begin with. Just how does a low interest rate environment stimulate growth? Growth comes from productivity, and productivity is the result of harder and more intelligent work, which in turn requires risk taking and motivation. Interest rates don't factor into the productivity—investment does. Besides, if low interest rates encourage borrowers to borrow, then they most likely discourage savers from saving. When the world is risk averse and wants to hold tons of cash and cash equivalents, investment is naturally weak, and that's why economic growth has been disappointingly slow.
Bank savings deposits—which pay almost nothing in the way of interest—have doubled since the end of 2008, and are now approaching $8 trillion. They have quadrupled in the past 14 ½ years, rising at an annualized 15% per year! Yet they pay almost no interest; demand for the safety of deposits must therefore be intense.
Service sectors in the U.S. and in the Eurozone are in decent shape, as the chart above shows.
The employment subindex fell from optimistic levels, but this series is notoriously volatile from month to month.
The business activity subindex is also at relatively healthy levels.
We're not going to see much in the way of stronger growth until economic policies increase the incentives to work and take on risk, and reduce the obstacles to investment.