Free Reports

How Dumb Is the Fed?

Jul 12, 2017

27

POITOU, FRANCE - This morning, we are wondering: How dumb is the Fed?

The question was prompted by this comment by former Fed insider Chris Whalen at The Institutional Risk Analyst blog:

  • [O]ur message to the folks in Jackson Hole this week [at the annual central banker meeting there] is that the end of the Fed's reckless experiment in social engineering via QE and near-zero interest rates will end in tears.

    'Momentum' stocks like Tesla, to paraphrase our friend Dani Hughes on CNBC last week, will adjust and the mother of all rotations into bonds and defensive stocks will ensue. We must wonder aloud if Chair Yellen and her colleagues on the FOMC fully understand what they have done to the US equity markets. [...]

    Once the hopeful souls who've driven bellwethers such as Tesla and Amazon into the stratosphere realize that the debt driven game of stock repurchases really is over, then we'll see a panic rotation back into fixed income and defensive stocks.

Bent and Distorted

If you believe the newspapers, the Fed has begun a 'tightening cycle'. It is on course to raise its key interest rate, little by little, in quarter-point increments.

It must know that this is a perilous thing to do. After so much market manipulation over such a long period, prices all up and down the capital structure - from junk bonds to quality stocks and solid real estate - have been bent and distorted.

After all, that was the idea: drive up the price of stocks and bonds by driving down interest rates. People would be forced to spend or invest their money rather than save it. And higher financial asset prices would make the rich feel even richer.

Walking down the street, the dollars would overflow from their pockets like turnips rolling off the back of a produce truck.

They'd feel so flush, they'd buy, buy, buy...sending the plain people into a flurry of trucking, toting, and busting their humps to provide them with goods and services.

Then, after the rich were fully satiated (after all, how many martinis can the 1% drink?), they'd have to invest.

Cash would flow into money-losing startups like Tesla and Snapchat. Headline acquisitions, such as Amazon's purchase of Whole Foods, would keep stock prices bubbling higher. And trillions of dollars in stock buybacks would make the rich even richer still!

Advertisement
  Free Report: Three Crisis Scenarios, and How They Could Impact India  
   
  India in Crisis 2017 special Report Claim your FREE report and learn the three disturbing reasons why the Diary editor Vivek Kaul believes India may be headed for a big crisis in the years to come.

Plus you will get the Diary...absolutely free.
Download This Special Report Now. It's Free.
 

Money Mirage

But the feds could only work this miracle by buying bonds. And the feds didn't have any money. What could they do?

No problem! They used their fake money, the post-1971 credit dollars - trillions of them...money they could create at will.

From the post-crash bottom in 2009 to today's top, US stocks and bonds registered a cumulative increase of about $21 trillion. And upon that mirage now rest the hopes, dreams, and contentment of millions of people all over the planet.

One has planned his retirement based on his gains over the last eight years. Another has taken out a loan against his stocks to fund his business. Still another - a major player on Wall Street - has a billion-dollar hedge fund portfolio...a leveraged bet on 'low vol', which depends on further support from the Fed.

And look at super investor Warren Buffett...

The latest headline news tells us his gifts to charities now top $27 billion. The money is to be used to fight illness and poverty worldwide. But the gifts came in the form of Berkshire stock - not cash. Imagine how the halt and the hungry will suffer if the stock goes down!

Classic Credit Bubble

Which brings us back to our question: How dumb is the Fed?

As you can see from the foregoing, the boom of 2009-17 was wrought by the Fed and paid for with fake money. It is a classic credit bubble, in other words - not genuine prosperity.

Almost all the new jobs created during this period were low-wage or part-time jobs in health care or government, not high-value jobs in manufacturing. That's why real earnings, per family, have scarcely improved...and real employment (as a percentage of the available workforce) has gone down.

All the bubbly action, in other words, is in the financial markets, not the real Main Street economy. And as the Austrian School economists tell us, every boom not financed on real savings must end in a bust.

Nothing comes from nothing. Fake money produces fake prosperity. Take away the fake money...and the fake prosperity goes 'poof', too.

Which is why the Fed will never, voluntarily, stop manipulating prices. It can't let the markets return to 'normal' price discovery.

Because the markets are likely to discover prices a lot lower than Dow 20,000.

'Normal' may be a lot higher than a 2% yield on a 10-year Treasury yield, too.

'Normal' may mean a deep depression as the economy shakes off the foolish investments and misallocations of the last eight years. 'Normal' would also mean the disgrace of Janet Yellen and Ben Bernanke, who are largely responsible for this bubble.

But 'normal' won't stop there. The crisis of 2008-09 was a repudiation of the Fed's fake-money debt bubble. The stock market crashed as the bubble deflated, just as it normally does. But then central banks went back to work, doubling down on their error with more hot air than ever before.

Federal debt alone almost doubled from about $10 trillion to about $20 trillion. Worldwide, $68 trillion in debt has been added since 2007 - a 45% increase - bringing the debt-to-GDP ratio to 327%.

All of this debt now hangs on the feeble reed of more ultra-low interest rate policies.

The Fed says it is going to return its interest rate policy back to normal...

No chance. It's not that dumb.

Regards,
BILL BONNER Founder, Agora Inc
Bill


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

Disclaimer: 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.

Recent Articles

Has Arun Jaitley Been Reading India's Big Government? October 23, 2017
If self-employment is the way out for India's jobs crisis, then the government should create conditions encouraging it.
Get 'India's Big Government' at Just Rs 199 Now October 18, 2017
Vivek's latest book is now available at a rare discount. Grab a copy now.
Our Plan to Save the Ranch October 18, 2017
How to increase fertility in the kingdom of cows.
Nobody Honks in Bali - Lessons for Indian Tourism October 17, 2017
Things India can learn to promote tourism from this small island.

Equitymaster requests your view! Post a comment on "How Dumb Is the Fed?". Click here!