The Fed's capabilities to engineer changes in economic growth and inflation are asymmetric. It has been historically documented that central bank tools are well suited to fight excess demand and rampant inflation; the Fed showed great resolve in containing the fast price increases in the aftermath of World Wars I and II and the Korean War. In the late 1970s and early 1980s, rampant inflation was again brought under control by a determined and persistent Federal Reserve. However, when an economy is excessively over-indebted and disinflationary factors force central banks to cut overnight interest rates to as close to zero as possible, central bank policy is powerless to further move inflation or growth metrics. The periods between 1927 and 1939 in the U.S. (and elsewhere), and from 1989 to the present in Japan, are clear examples of the impotence of central bank policy actions during periods of over-indebtedness. Four considerations suggest the Fed will continue to be unsuccessful in engineering increasing growth and higher inflation with their continuation of the current program of Large Scale Asset Purchases (LSAP)...
Bipartisan Proposal Would Substantially Reduce Budget Crisis
For the greater part of human history, leaders who were in a position to exercise power were accountable for their actions. The problem we are faced with today is that our political and (frequently) business leaders are not being held responsible for their actions. Thomas Sowell sums it up well: "It is hard to imagine a more stupid or more dangerous way of making decisions than by putting those decisions in the hands of people who pay no price for being wrong." Fortunately, there is an institution that exercises control over the academics at the Fed; it is called the 'real' market economy... and it has badly humbled the professors at the Fed.
We strongly suspect that both government debt growth and money supply inflation will continue unabated – any pause will immediately bring about the kind of short term economic pain these policies have explicitly sought to prevent and will therefore be quickly reversed. It is not unlike the situation the revolutionary assembly of France found itself in during the late 18th century: when it issued new money, industry seemed to revive. As soon as it stopped, industry slumped again. And so it was decided to issue ever more money, until the entire scheme blew up. There can be little doubt that modern-day governments are on the road to a similar date with destiny – and lately the speed at which they travel toward it has increased markedly.
If you listen to TV commentators, you’ve been told the worst is behind us. Growth is picking up, and Europe is coming out of its slumber. No one seems to be concerned that this tepid below-2-percent growth is being entirely fed by the central bank’s massive money printing. It’s a “growth at any price” policy. How quickly we forget. We currently fear Fed tapering, as we should. Yet, we should be even more fearful that it doesn’t taper. Today, we really have a dreaded choice of losing an arm now or two arms and a leg tomorrow. Because the price distortions have been massive, the adjustment will be horrendous. Government policy makers and government economists simply do not understand the critical role of prices in helping discovery and coordination.
Secular bull markets are great parties. Investors arrive from secular bears really wanting to take the edge off. As the bull proceeds, above-average returns become intoxicating. By the time it is over, the past decade or two has delivered bountiful returns. In contrast, secular bears seem like hangovers. They are awakenings that strip away the intoxication, leaving a sobering need for an understanding of what has happened. If history is a guide, the inflation rate will at some point trend away from the present price stability. The result will be a significant declining trend in P/E. If this occurs over a few years, the market losses will be dramatic. These processes take many years. Be careful not to let hope for the next secular bull mask the reality of the current secular bear.
Billionaires and political lackeys alike have been falling all over themselves in the rush to praise the Federal Reserve's unprecedented monetary intervention since 2008. That billionaires and political hacks, apparatchiks and toadies cannot laud the Fed's Cargo Cult enough is no surprise: the billionaires and the government that feeds them both gained handsomely from the Fed's policies. As the Fed-induced asset bubbles in stocks, bonds and real estate follow the inevitable Supernova track to implosion, that we've reached Peak Federal Reserve will be obvious - in hindsight.
There may be temporary 'benefits in terms of employment gains' if the Fed creates an even more gigantic echo bubble than it has already done. We are willing to grant that much. The Fed apparently believes these days that there should be no limits whatsoever to the Fed's monetary pumping. 'Inflation' targets? Forget about it! Asset bubbles? Who cares! It is as if the past 20 years had not happened – as if they had simply erased the whole period from his memory. Do they really believe that pumping up another giant bubble will have more benefits than drawbacks? Where does it all end? However, there is no such thing as a free lunch, and there cannot be an 'eternal boom' by simply continuing to print, as once envisaged by Keynes. All that will happen is that the ultimate disaster will be even greater. In fact, is seems ever more likely that the next disaster will be the last one of the current monetary system.
Fingers of Instability
While everyone knows that there is a profound ideological schism when it comes to those for and against the Affordable Care Act, aka Obamacare, what may not be appreciated is that Obamacare was, and still is, the most contentious and polarizing legislation in the history of Congress. At least, it is according to JPMorgan. In the chart below, JPM's Michael Cembalest shows that the "disagreement gap" between Republicans and Democrats in the House and Senate, over 100 years of impactful legislation, has never been greater than with Obamacare.
Moments ago Mario Draghi's nightmare just got worse following a release by the ECB overnight that loans to the private sector dropped 2 percent from a year earlier. That’s 16th monthly decline and the biggest since the start of the single currency in 1999. "The data shows a depressing picture for the credit market," said Annalisa Piazza, an analyst at Newedge Group in London. "Although the ECB made clear that the ECB cannot do much to boost credit to the corporate sector, we expect the current picture for loans to remain one of the key reasons behind expectations of a prolonged period of accommodation." Translated: all monetary transmission mechanisms in Europe are completely broken, which in turn feeds the feedback loop of the deleveraging depression, leading to even less demand for loans, more deleveraging by banks ad lib.
The best summary of what has (not) been going on in the downward drifting equity markets comes from DB's Jim Reid, quoting: "Markets are in non-panicky limbo at the moment ahead of the upcoming US budget debate. US equities fell for the 5th day in row (S&P 500 -0.27%) and although this is the worst run since the Christmas/New Year’s Eve period of 2012 (due to the fiscal cliff debacle), the cumulative fall is only -1.9% over this decline. Meanwhile Treasuries hit a 7-week low in yield as they recorded their 12th decline in the last 14 days." As has been the case over the past week, stocks in Asia have generally traded lower with the exception of the Nikkei225 which day after day continues to do its insane penny stock thing, first dropping -1.5% only to close up 1.2% on absolutely no news, but some chatter the Abe administration would raise the sales tax on October 1, only to offset the fiscal benefit by lowering corporate tax. How this has any net impact is beyond us. Proceeding to Europe, stocks failed to sustain the initial higher open and moved into negative territory, with Italian asset classes underperforming, as market participants digested reports citing Italian MP Gasparri saying that PdL lawmakers are ready to quit if Berlusconi is ousted. This in turn saw a number of Italian banking stocks come under intense selling pressure, with the Italian/German yield spread widening in spite of supportive reinvestment flows that are due this week.
There is a reason why every fiat currency in the history of the world has eventually failed. At some point, those issuing fiat currencies always find themselves giving in to the temptation to wildly print more money. Today, the Fed finds itself faced with a scenario that is very similar to what the Weimar Republic was facing nearly 100 years ago. Like then, the U.S. economy is struggling and like the Weimar Republic, the U.S. government is absolutely drowning in debt. Unfortunately, the Fed has decided to adopt the same solution that the Weimar Republic chose. The Fed is recklessly printing money out of thin air, and in the short-term some 'positive things' have come out of it. But quantitative easing worked for the Weimar Republic for a little while too.
Men have had their stab at making the world into what they wanted and they made a pretty poor show of it all we might say when we look at the economy.
The process the Fed is wrestling with is no different than that of the drug addict. After a certain point, dependency develops. Then the withdrawal process is so painful it is not willingly accepted. The drug analogy is appropriate up to a point. Here is a major problem with the analogy. The drug addict brings the outcome on himself. Those who will suffer the most for the Fed’s actions are not responsible for the pain they will endure. Regardless, the pusher has made most of us junkies. We have been forced into an economic haze that seems real but is not. Whether we know it or not, we are hooked. A great “drying-out” period lies in front of us. Few have understanding of what “economic cold turkey” means, but we will all learn.