A Hundred Years Of Fed Solitude, Or An Artificial Lack Of Volatility In A Time Of Fiat Cholera
The following observations by John Lohman are a must read for all mean reversion junkies. By tracking the correlation between credit expansion and assorted metrics of volatility, Lohman concludes that the one primary tradeoff given up by the investor class (voluntarily) and the broader population (unknowingly) in exchange for a 98% decline in the value of the dollar, and thus purchasing power, since the inception of the Jekyll Island monster, is a constant and gradual decline in volatility. What this means, however, is that by entering the period of greatest systemic deleveraging, America is once again inviting volatility. What is more troubling is that unlike before, the ongoing dollar value destruction is not matched with a favorable attribute, namely an offset vol reduction. In other words, society and the investing class has gotten to the point where the marginal utility from having a Federal Reserve bank, has essentially disappeared. Which is simply all the more reason to disband the most destructive central-planning organization in the history of the communist world.
Per John Lohman:
The Federal Reserve Act of 1913 was largely a response to the panic of 1907. With the stroke of a pen, Woodrow Wilson created the mooncalf that will ultimately destroy the very entity it was designed to save. What was primarily intended to be a lender of last resort and a controller of “seasonal” fluctuations in money supply has morphed into a monstrosity that is attempting to control virtually aspect of financial markets and the real economy.
The first thing many opponents of the Fed point to is the (sometimes not so) steady erosion in the purchasing power of our currency. As shown in the chart below, consumer price inflation was effectively zero before 1913 but has risen virtually every year since. Also noteworthy is the period after 1933’s executive order that all gold be turned in to the Fed. Since then, inflation has risen just under 4% per year.
Now, this is the point at which Keynesian milksops would argue that the achievement of stability (via lower volatility) in prices outweighs the steady erosion of the dollar. The 4% annual increase simply becomes a part of expectations and is built into all business contracts and agreements (indeed, the Fed perpetuates this myth with its current inflation targets). The Krugmans would then point to something like the plot below which highlights the dramatic decline in the volatility of nominal output, noting that the Fed has successfully lowered the standard deviation from 20% to 2% since the Reserve Act was amended in the 1930’s (broadening the Fed’s powers).
So what could possibly be wrong with ‘price stability’ and lower volatility in overall nominal output? How could reducing the frequency and severity of recessions be a bad thing?
The answer, of course, is that artificially suppressing the amplitude of the business cycle paints a false perception of the underlying levels of risk. In effect, the Fed’s manipulation of the credit cycle over the course of its putrid existence had (until 2008) convinced consumers, businesses, and local governments that business cycle risk was a thing of the past. So America, en masse, did the obvious: dissave and take on levels of debt that were inconsistent with the real level of economic risk.
The eejitic Keynesian response at this point is that we can simply solve this debt problem with more debt. It has worked for the last 75 years, so it will work again.
No, it won’t. By definition, consumption (70% of the economy) cannot return to pre-crisis levels in a deleveraging environment. For evidence that future deleveraging will occur (as well as additional proof that business cycle volatility drives the debt cycle), consider the final chart below. It plots the same measure of volatility as above (but inverted this time) against home ownership. In all likelihood, we have barely begun the deleveraging process.
Thank you Ben & Company. You can go home now.