The US Fed might cease to exist in the next decade...

Jan 7, 2014

In this issue:
» High unemployment haunts Europe
» Have inflation indexed bonds worked?
» 2014 is election year for emerging countries
» India grapples with low quality manufacturing jobs
» ...and more!

Ben Bernanke will step down as the chief of the US Federal Reserve by the end of this month after being at its helm for the last 8 years. His tenure saw the worst financial crisis since the Great Depression and he will be infamously remembered as the man who printed money like there was no tomorrow.

Janet Yellen has been confirmed as the new chief who will step into Bernanke's shoes. For the time being, it seems quite likely that Yellen will carry on where Bernanke left off. This means that we may not see the end yet of the Fed's easy money policy.

Indeed, noted investor Jim Rogers has come out strongly against the Fed. As reported on Moneynews, Rogers opines that Ben Bernanke has set the stage for the collapse of the US central bank within the next decade. What is more, he has also held Bernanke responsible for turning the US' fiscal balance sheet into 'garbage'.

Central banks are primarily responsible for coming out with monetary policies that foster growth and enhance the general well being of an economy. If the Fed's past is anything to go by, it has not really managed to achieve its objectives. US Fed was guilty of following a loose policy much before the 2008 financial crisis. Indeed, the then Fed chief Alan Greenspan, chose to keep interest rates at record lows and encouraged Americans to go on a borrowing binge. That culminated in the 2008 crisis and since then, Ben Bernanke has only continued with that policy. The impact of this has been massive debt on the nation's books with no meaningful recovery in the economy.

What is more, the US government is also to blame for expanding the role of the Fed and thrusting on it the responsibility of driving growth when that is something that falls in the domain of the government. This has led to the Fed hogging too much of the limelight when it needs to be doing its job behind the scenes. Rogers, in this regard, states, "One hundred years ago you could not have named the head of most central banks in the world. Now they're all rock stars."

We agree with Rogers and his criticism of the US Fed's loose policies. The current state of affairs cannot continue for long and at some point in time in the future it will dawn on most that the Fed has damaged the economic health of the US. When that happens, it will hardly be surprising, if the Fed as an institution collapses. What is more, it will be interesting to see if other central banks around the world witness the same fate. After all, the European Central Bank and the Bank of Japan are equally guilty of following the US and unleashing a wave of unwanted liquidity around the world.

Do you think the US Fed will cease to exist in the next decade? Let us know your comments or share your views in the Equitymaster Club.

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 Chart of the day
High unemployment has been the bane of most of the developed economies for quite some time now. This has been particularly prominent in Europe, which has also been grappling with massive government debt. Unemployment levels, particularly in Spain and Greece, have gone beyond the 25% mark. Though not as high, the 7% unemployment rate in the US is still high compared to its standards. Indeed, it is quite obvious that the loose money policies of central banks have done nothing in terms of improving job prospects. All it has done is inflate asset prices and government debt. The governments of these countries will have to focus on a more meaningful strategy that will address these structural issues and enhance economic growth going forward. But for the time being, most of them seem content with printing only money.

High unemployment haunts the developed world

We recently came across an article on Firstpost that drew a simplistic yet interesting linkage between fiscal deficit and inflation bonds. Over the past few months the government has not just failed to curb fiscal deficit and inflation. Its attempt to offer inflation hedged returns via inflation indexed bonds (IIBs) too fell flat. The author of the article on Firstpost argues that lower commissions (by RBI) on IIBs to banks as compared to those offered by LIC for ULIPs is the key reason for such dual failure. That LIC acts as buyer of last resort for government's unpopular disinvestment programmes is well known. Offering incentives on IIBs that are higher than that on LIC's ULIPs will put the insurer's revenue growth at risk. Hence it seems that the government chose to keep the commissions to banks for vending IIBs minimal. And therefore the IIBs have yet to find enough acceptance amongst investors. Now while this simplistic story seems easy to believe, we are not quite in agreement. That IIBs have to compete with the fixed deposits offered by banks themselves is a no brainer. Secondly irrespective of whether banks endorse them the instrument would have been popular had the tax adjusted returns been attractive enough.

Markets hate uncertainty. A slight emergence of the same and the stocks are seen running for cover. We believe it is the power stocks that are bearing the brunt of this uncertainty currently. LiveMint reports how the BSE Power index has been amongst the worst hit ever since the decision of the new Chief Minister of Delhi to cut power tariffs. In fact, stocks of private players like Tata Power have seen their stock prices fall as much as 10%. Now, logic says that generators like Tata Power shouldn't be affected as the Government is expected to reimburse them. However, the discoms are already reeling due to non-recovery of earlier dues. And any further losses are likely to make matters even worse. Besides, there is another threat in the form of general elections looming large. And political parties may not be averse to effecting tariff cuts in order to garner more votes . All in all, the markets may well be justified in treating power stocks with caution. A careful evaluation of stocks from the power space is therefore in order.

An election year is a year of uncertainty for stock markets. Hence, most investors prefer to sit on the sidelines. And wait for the verdict to be announced before committing fresh funds. 2014 could well be deemed as an election year for emerging market countries. Five emerging market economies including India are set to go for polls in 2014. Hence, despite abundant liquidity most fund managers are adopting a wait and watch approach. Amongst all emerging markets that are set to go for elections, India is perhaps the only one which is drawing considerable interest amongst investors.

An expected change in political landscape has renewed investor interest in an otherwise paralyzed economy. In fact, quite a few MNC broking houses have turned bullish on India expecting a change in power at the Centre. However, we feel that basing investing decisions on political outcomes is a naive approach. Take the case of 2009 for example. Markets went gung ho once UPA government came to power expecting a reformist approach. However, instead of reforms, UPA government got plagued with policy paralysis and corruption. Hence, believing that change of power can do wonders to the stock market could be a wishful thinking. Also, there are very little chances that the opposition would get a clear majority. Hence, a coalition government may be formed at the Centre. This may bring many compulsions to decision making. Thus, the India story may not unfold as investors expect.

Last year, India was faced with a serious challenge on the current account front. The import cover was shrinking. The Indian rupee hit an all-time low against the US dollar. This prompted the Indian government to wage a full blown war against gold imports. While their ire against gold is well understood, the proliferation of 'Made in China' products in the Indian markets beats logic.

India has a huge working population of nearly half a billion people. Despite this fact, why is the manufacturing sector in India floundering? Even six decades after the advent of planned development, why does a large chunk of India's population still continues to depend on agriculture? Why do we have to rely on Chinese imports for even items such as rakhis and Ganesha idols?

Whatever jobs have been created in the manufacturing sector are temporary, low quality and unsustainable. This raises several long term challenges for an economy that hopes to harness its demographic dividend.

In the meanwhile Indian stock markets have shed their gains and are trading weak. At the time of writing, the benchmark BSE Sensex was down by 93 points (0.45%). Auto and Pharma stocks were trading strong while Realty and Oil and Gas stocks were trading weak. Most of the Asian stock markets were trading lower led by China and Japan. The European markets opened on a negative note.

 Today's investing mantra
"You do not gain as much from periods of unusual prosperity as you lose in periods of depression when you are in business. That is almost an axiom." - Benjamin Graham

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4 Responses to "The US Fed might cease to exist in the next decade..."

c v krishnakumar

Jan 8, 2014

The idea that FED or for that matter any central bank will collapse is completely outlandish, to put it mildly. Jim Rogers just made a casual comment and here we go taking it as some sort of gospel truth!! Yes, there could be a drastic change in some of its policies and functioning but it, along with other central banks will continue to play a pivotal role in the world economy.


Satinder Chawla

Jan 8, 2014

Economy as a subject has been made so complex today that the general public completly ignores it due to a failure of understanding/training and hence gives or leaves the responsibility of managing what is very important to their own financial well being, into the hands of so called 'experts'. This complexity opens the door to manipulation in the form of 'authority or expert opinion'. Ultimately it is about Production. Money should be equivalent to the amount of real goods and real estate in the economy. Any manipulation by reducing the money supply or increasing it would lead to a recession or inflation. Central banks today manipulate the flow of money by controlling the money supply. However, the money from the loose monetary policy simply encourages people to take loans to invest in hot sectors which themselves have become hot only due to loose monetary injections (real estate, stock markets etc) thus encouraging bubble which is bound to deflate causing a lot of hurt to anyone included in the cycle. I agree that central banks in general have not done their job and an improvement should be made in the system.

Like (1)

joseph oommen

Jan 8, 2014

every nation has to implement its monetary policies which only a central bank can do. as such the demise of a central bank is only imagainative exaggeration. IF the monetary pomicies per se fail then govt willhave to change its monetary policies and the only vehicle available for govt is central bank. it is a misnomer to say that central bank ie FED functions totally free from governmental persuation. No central bank can exercise full authoirty in defiance of govt or function in a vaccum. if feds policies are wrong and creats havac in the future it will bring in new policies just as the depression of 1927 and 2008 was handled by FED

Like (1)

Prabal Biswas

Jan 7, 2014

I really don't know how much prudent it is to make comments about Fed, as we do not know how to solve the problems in our courtyard. People who suggest dramatic solutions are mostly miles away from the hot seat.

Like (1)
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