Feds go Full Retard - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 14 July 2014
Feds go Full Retard A  A  A

Bonn, Germany

"Everybody knows you never go full retard."
- Tropic Thunder

Dear Diary,

It looked like stocks were selling off last week. But the market steadied itself on Friday. Calm, complacency, and confidence -- almost every measure tells us that we have nothing to worry about.

Still, since we have nothing to worry about, we will worry about nothing. Or as Churchill might say, if we have nothing more to fear than fear itself...surely, we're missing something.

But let us move on, by turning our heads around and looking at the road by which we came to be where we are. In this we have been greatly aided by reading David Stockman's book, 'The Great Deformation,' as well as his blog, 'ContraCorner.' Stockman had a big advantage. He was at the heart of the federal government, as Ronald Reagan's first budget director. Then, he was in the belly of the beast on Wall Street, as a partner in a major private equity firm. In government and in finance, Stockman was on the inside when the major decisions and developments of the past 40 year occurred.

By the time Ronald Reagan was first elected president, the US was already headed down the road to perdition. Over the preceding thousands of years, humans had learned three important lessons: 1) that they could not rely on authorities to manage a paper currency; it had to be backed by gold; 2) that governments must not run repeated and large deficits; 3) that markets must allowed to freely discover prices rather than have them imposed by authorities.

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After so many episodes...over such a long time...causing so much misery...only a mental defective would now ignore these lessons. Yet, that is exactly what the feds have done.

In the early '80s, the most recent major test of these verities was still very much in front of us. The Soviet Union still existed at the time and busy proving that central planning doesn't work. It was collapsing under the weight of administered prices that had so distorted its economy that it had become a value subtracting enterprise. That is, for each rouble of investment in raw materials, energy, or labor, less than 1 rouble of finished product or service emerged.

We saw this in action. On a trip from Moscow to Minsk in the late '80s or early '90s, we were seated next to a young woman who spoke English. We noticed that she had a toilet set in her lap. This seemed a bit odd, so we asked.

    "Oh...you know...everything is screwed up here. Airline tickets are very cheap. It's cheaper for me to fly to Moscow to buy a toilet seat than it is to buy the seat in Minsk. Besides, there aren't any toilet seats in Minsk."
Without freely-set (or 'discovered') prices, you never know whether you're coming or going. Is something worth doing or not? You don't know, because the prices don't tell the truth.

In the Soviet Union, prices lied. And after six decades of financial mendacity, the economy was failing.

Instead of learning from this example, or from the other examples over two-thousand plus years of market history, the US was busy un-learning. In '68 and '71 it had already taken gold out of its money system. Over the next three decades, it would also run the biggest deficits in its history; and it would become bolder and bolder in its efforts to replace discovered prices with ones it imposed itself. The price of money (or credit) is, of course, the most important price in an economy. It affects all other prices, as we have seen. If the price is too low, it causes excess borrowing...which money then finds its way into various sectors of the economy.

The tendency to fix the price of credit, rather than discover it, took a leap forward after 1987, when Alan Greenspan found it convenient to hold interest rates down for extended periods of time in order to manipulate the economy into booms, and then bubbles.

In theory, the Fed could move rates lower to stimulate lending...and growth. Then, when the economy 'overheated'...it was the job of the Fed, in the words of William McChesney Martin, to "take away the punchbowl." In practice, the punchbowl rarely got taken away...and when it was removed, it was only a matter of time before it came back, with the punch stronger than ever. Business, investors and consumers gradually came to rely on it. And the Fed gradually became aware that it couldn't take away the punchbowl without putting everyone into a severe dry-out funk.

So interest rates went lower and lower , from 1983 to 2009, when the Fed's key lending rate finally hit zero. We have now gone for 68 quarters of ZIRP. And Janet Yellen tells us that even though QE will be removed by the end of the year, ZIRP will continue. The economy still needs it, she says. She does not explain how the economy came to be dependent on this heavily-spike punch. She does not take responsibility for making the economy 'substance dependent.' Nor does she offer any real theory as to how the economy will be able to afford honest interest rates in the future.

Poor Ms. Yellen. She should know. "You never go full retard, man."

More to come...

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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