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Insanity, like criminality, usually starts small and expands with
time. In the Fed’s case, the process began in the 1990s with a series of
(in retrospect) relatively minor problems running from Mexico’s
currency crisis thorough Russia’s bond default, the Asian Contagion
financial crisis, the Long Term Capital Management collapse and finally
the Y2K computer bug.
With the exception of Y2K – which turned out to be a total non-event –
these mini-crises were threats primarily to the big banks that had
unwisely lent money to entities that then flushed it away. But instead
of recognizing that this kind of non-fatal failure is crucial to the
proper functioning of a market economy, providing as it does a set of
object lessons for everyone else on what not to do, the Fed chose to
protect the big banks from the consequences of their mistakes. It cut
interest rates dramatically and/or acquiesced in federal bailouts that
converted well-deserved big-bank losses into major profits.
The banks concluded from this that any level of risk is okay because
they’ll keep the proceeds without having to worry about the associated
risks.
At this point – let’s say late 1999 — the Fed is corrupt rather than
crazy. But the world created by its corruption was about to push it into
full-on delusion.
The amount of credit flowing into the system in the late 1990s
converted the tech stock bull market of 1996 into the dot-com bubble of
1999, which burst spectacularly in 2000, causing a deep, chaotic
recession.
Instead of letting this (also well-deserved) crisis run its course,
the Fed again protected Wall Street by cutting interest rates to
unprecedentedly-low levels, something that rational observers warned
would cause another bubble of some kind. Sure enough, the resulting
housing bubble expanded to epic proportions before popping in 2007, with
results that most readers remember clearly.
The Fed then completely lost it, setting short-term interest rates at
literally zero and buying trillions of dollars of bonds to push
long-term rates down to record low levels. This lit a rocket under asset
prices, enriching the banks and their wealthy clients while saddling
the rest of society with debilitating student loan, car, house and
credit card debt. Again – to observers outside the Keynesian bubble
delusion – this was not sane behavior. But in the context of an
overriding compulsion to save Wall Street at any cost, it was sold – and
bought – as somehow heroic rather than pathological.
Which brings us to today, 9 years into the latest bubble-driven
recovery with debts everywhere at record levels, stocks and bonds priced
for perfection, and interest rates still at historically low levels.
Now the Fed is making plans for the next, inevitable recession. And not
surprisingly, given the past three decades’ trajectory, those plans are
even crazier than their predecessors:
(Reuters)
– Global central bankers should take this moment of “relative economic
calm” to rethink their approach to monetary policy, San Francisco Fed
President John Williams said Thursday, warning that to fight the next
recession, as with the last, they would need to do more than just cut
interest rates.
Other Fed officials, including Chicago Fed Bank President Charles
Evans, have in recent days urged a strategy review at the Fed, but
Williams’ call for a worldwide review is considerably more ambitious.
With many major economies facing slower growth and thus lower
interest rates even when unemployment is low, central banks will need to
find ways to stimulate their economies that work even when many other
countries are also trying to boost their growth.
“We will all be better able to contain the next economic recession if
we develop approaches that succeed even when many countries are
simultaneously constrained by the lower bound,” Williams said at the
opening of a two-day conference on Asian economic policies at the San
Francisco Fed. “And that means taking into account the nature of
monetary policy spillovers.”
Strategies that central banks should consider including not only the
bond-buying and forward guidance used widely in the last recession, but
also negative interest rates that was used in some non-U.S. countries,
as well as untried tools including so-called price-level targeting or
nominal-income targeting. Central banks may also want to consider
setting a higher inflation target, he said.
—————————–
(MarketWatch) – Inflation has been too low for too long and the U.S.
central bank has to alter its communications with the markets to
convince investors the central bank is willing to let it run hotter than
the 2% target, said Charles Evans, the president of the Chicago Fed, on
Wednesday. In a speech in London, Evans said the Fed must alter its
statement to make clear that its inflation target of 2% is not a
ceiling. “Our communications should be much clearer about our
willingness to deliver on a symmetric inflation outcome, acknowledging a
greater chance of inflation at 2.5% in the future than what has been
communicated in the past,” Evans said. Many economists and Fed officials
think the low inflation seen this year is due to transitory factors.
But Evans said “it gets harder and harder for me to feel comfortable”
with the transitory explanation “with each low monthly reading.”
Some thoughts
Think of the Fed – and the other major central banks – as a person who
does a stupid but not necessarily criminal or pathological thing, and
then starts committing ever-more serious crimes to cover up the original
act. Each new atrocity is justifiable in the moment, since it keeps the
perpetrator out of jail, but the later stages of the process seem
criminally-insane to rational bystanders. Here’s some of what the Fed is
planning and why it’s bad:
- Negative interest rates are a distortion of markets that imply a
fundamental misunderstanding of the purpose of markets, which is to
efficiently allocate capital. When savings generates a negative return,
as they do when bonds and bank accounts charge rather than pay interest,
capital shrinks rather than grows. There is no possibility of
“efficient allocation” when returns are negative.
- “Evans said the Fed must alter its statement to make clear that its inflation target of 2% is not a ceiling.”
One of the hallmarks of obsession is a fixation on one thing to the
exclusion of everything else. The Fed official quoted here is living in a
world where real estate, bond and stock prices are at record levels,
and consumer, corporate and government debt is soaring. And where a
painting, wristwatch, and piece of paper
with a single line of text recently sold, respectively, for $450
million, $17 million, and $1.8 million. And he sees unacceptably-low
inflation.
- “Strategies that central banks should consider including
not only the bond-buying and forward guidance used widely in the last
recession, but also negative interest rates that was used in some
non-U.S. countries, as well as untried tools including so-called
price-level targeting or nominal-income targeting, he said.”
Price-level targeting, since it focuses on the wrong prices, will
simply blow up even bigger asset bubbles (thus illustrating another
definition of insanity: repeating the same activity while expecting a
different outcome).
And nominal-income targeting? Here again, it’s easy to raise the average
income by enriching the 1%, but using negative interest rates (which
lower the incomes of small savers) and asset purchases (which bypass
small savers who lack big stock and bond portfolios) to help society as a
whole is worse than pointless. Which is another sign that the Fed
literally doesn’t see the biggest part of the economy — financial asset
prices — because those prices aren’t accounted for in its “aggregate
demand” economic models.
Anyhow, the list of delusions and other pathologies could go on for a
while. Suffice it to say that when the next recession hits – which,
based on the action in junk bonds, subprime mortgages and the yield
curve, may be fairly soon – some truly crazy ideas will be dumped on a
still (amazingly) unsuspecting public.
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John Rubino runs the popular financial website DollarCollapse.com. He is co-author, with GoldMoney’s James Turk, of The Money Bubble (DollarCollapse Press, 2014) and The Collapse of the Dollar and How to Profit From It (Doubleday, 2007), and author of Clean Money: Picking Winners in the Green-Tech Boom (Wiley, 2008), How to Profit from the Coming Real Estate Bust (Rodale, 2003) and Main Street, Not Wall Street(Morrow, 1998). After earning a Finance MBA from New York University, he spent the 1980s on Wall Street, as a Eurodollar trader, equity analyst and junk bond analyst. During the 1990s he was a featured columnist with TheStreet.com and a frequent contributor to Individual Investor, Online Investor, and Consumers Digest, among many other publications. He currently writes for CFA Magazine.
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The author is not affiliated with, endorsed or sponsored by Sprott Money Ltd. The views and opinions expressed in this material are those of the author or guest speaker, are subject to change and may not necessarily reflect the opinions of Sprott Money Ltd. Sprott Money does not guarantee the accuracy, completeness, timeliness and reliability of the information or any results from its use.
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