Four Words that can Trigger a Four-Letter Word

20 NOVEMBER 2015

The English language, like any language, was designed to help communicate an idea, a thought, a feeling, a decision....

But, sometimes, the crafting of the words into a sentence can lead to confusion, fear, and angst.

A lawyer told me that some of the trickiest questions asked of any defendant in a court case can be:

  • Have you stopped beating your spouse, or
  • Have you stopped taking bribes, or
  • Have you stopped eating beef?

"Please answer with a 'Yes' or a 'No'," says the wily lawyer.

You are trapped.

A "Yes" - the lawyer explained - to any of the above 3 questions can get you into a lot of trouble as it implies that you were indulging in that alleged act and had stopped recently.

You are, therefore, guilty for past crimes.

But if you said "No" it means that:

  • You confess that you are still in the habit of beating your spouse and, therefore, need to be punished;
  • You confess that you still have your hand in the till and are taking bribes and, therefore, need to be punished;
  • You still enjoy eating beef and, therefore, need to be punished.

Now try asking the Federal Reserve Board the question:

  • Are you still keeping interest rates low so that speculators can continue having a field day and ensure that the bonus pay outs of the financial honchos can reach peak levels by Christmas?

The Fed can answer with a "Yes" or a "No".
A "Yes" would mean that the Fed did all this rescue effort and pumped up its balance sheet by USD 4.5 trillion since September 2008 to feed it to the Wall Street crowd.
A "No" would mean that they were doing it - but have decided to stop.

Coordination with style: different banks, same printing
Central Bank 2013 activity 2015 activity
US Fed USD 85 bn / month Zero
Europe ECB USD 11 bn /month USD 68 bn / month
Japan JCB JPY 70 trillion / month JPY 80 trillion / month
Total USD 93 bn / month USD 75 bn / month

Source: www.federalreserve.gov. www.ecb.europa.eu, www.boj.or.jp

Guilty - but unpunished
The Fed, sets monetary policy in the US and - by that very act of grandness - can boom or bust global financial markets and determine the fate of the economies of smaller countries.

Very few believe that the Fed's money printing extravaganza and zero interest rate policy has helped the global economy grow. Most know that the financial services sector has profited immensely from the rescue act launched by global central banks. The cheap money policy that was put in place since the collapse of Lehman Brothers on September 15, 2008 was a handout. The benefit to Main Street, as the real economy is described, has been zero.

Many argue that the global economy would have been far better off if the Fed had done nothing and allowed banks to fail and bankers to commit suicide by jumping off their penthouse office suites. Iceland has proved that taking a knock on the chin is generally good for the soul. A recent report said that the GDP of Iceland had surpassed the previous peak level of 2007. And Iceland has put a few dozen bankers in jail. The harried citizens, meanwhile, never lost their social benefits and, therefore, were looked after. The critics of this "let the bankers fry" policy say that Iceland is a small country and therefore not representative of the global scale of the problem. Fair enough. But those proponents of the rescue of the financial firms with cheap money don't have a model country that tells us that the financial bail-outs worked (for the rest of the citizens, not only the financial firms). Yet, they went ahead with their experiment without trying to find any proof that it works.

Having avowed to be data-driven and having said multiple times that all Fed policy is decided by what happens in the US economy and not by events in the global economy - and certainly disdainful of the emerging markets - the Fed did not move into "lift off" stage. It stayed grounded in its own lie that monetary policy will revive the US economy. The Fed deferred the decision to increase interest rates at its September meeting by 0.25% and cited the rumblings in China as a reason.

Now, the minutes of the October meeting have been release. And the four words that are troubling the financial markets are: "at its next meeting".

The debate is whether a rate hike will happen for sure "at its next meeting" on December 15th and 16th, or whether there will be more discussions "at its next meeting". So far the market is suggesting that there will be a 65% probability of an increase in interest rates. But it is possible that this probability will decrease over the next few days as soothsayers predict there is likelihood to be a discussion at the next meeting. And, in any case the expectation is that the increase in interest rates will be gradual. The long term average rate of interest in the US has been closer to 3.5%. Since the Fed meets 8 times year - and assuming that the Fed will increase rates by 0.25% every time - it will take 14 meetings to get to that long term average.

The world is in an irrational place in economic history.

The coordinated interest rate cuts by the central banks of the developed world have resulted in a "risk-on" mood. People are willing to roll the dice. The bosses at the casino don't want you to sit idle on your cash. In the Euro zone, Germany can borrow money from you for five years - and you pay them to take your money. Spain and Italy - suspect countries in the aftermath of Lehman - can borrow money at 2% - lower than what USA can borrow at. The gamblers also believe that - were something to go wrong, there is the "Greenspan Put" - the Fed will bail out speculators.

For now the focus is on four words: "at its next meeting."

Soon, it may be another four letter word that occupies the minds of the traders: "sell".


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Disclaimer: The Honest Truth is authored by Ajit Dayal. Ajit is Founder of Quantum Advisors Pvt. Ltd and Quantum Asset Management Company Pvt. Ltd. The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and has not been authenticated by any statutory authority. The author, Equitymaster, Quantum AMC and Quantum Advisors do not claim it to be accurate nor accept any responsibility for the same. Please read the detailed Terms of Use of the web site.

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