The Fed Is Not Your Friend

Tyler Durden's picture

Submitted by David Stockman via Contra Corner blog,

During the last 64 months “buying the dips” has been a fabulously successful proposition. As shown in the sizzling graph of the NASDAQ 100 below, at it recent peak just under 4,000 this index of the high-growth, big cap non-financials stood at an astonishing 3.5X its March 2009 low. Moreover, during that 64 month period, there were but five minor market corrections—-the three largest reflecting just a 7-8% dip from the previous interim high. And as the index closed upon its current nosebleed heights, the dips became increasingly shallower, meaning that the reward for buying setbacks came early and often.

So yesterday’s 2% dip will undoubtedly be construed as still another buying opportunity by the well-trained seals and computerized algos which populate the Wall Street casino. But that could be a fatal mistake for one overpowering reason: The radical monetary policy experiment behind this parabolic graph is in the final stages of its appointed path toward self-destruction.


In fact, this soaring index reflects the most artificial, unsustainable and dangerous Fed created financial bubble ever. That’s because its was the untoward product of a completely busted monetary mechanism.  What has happened is that the Fed’s historic credit expansion channel of monetary transmission has been frozen shut ever since day one of the massive Bernanke monetary expansion which began in August 2007, but went into warp-drive in the weeks after the Lehman event a year later.

Yet this madcap money printing campaign was a drastic error because it failed to account for the immense roadblock to traditional monetary stimulus that had been built up over the last several decades—namely, “peak debt” in the household and business sector. This condition means that monetary easing and drastic interest rate cuts have not elicited a surge of consumer borrowing and business capital spending and hiring as during past business cycle recoveries.

Instead, the entire tsunami of monetary expansion has flowed into the Wall Street gambling channel, inflating drastically every asset class that could be traded, leveraged or hypothecated. Stated differently, 68 months of zero interest rates had virtually no impact outside the the canyons of Wall Street. But inside the casino, they provided virtually free money for the carry trades, causing an endless bid for leveragable and optionable financial assets.

But now that the monetary flood is cresting, financial asset values hang in mid-air like Wile E. Coyote. Stranded there, they are nakedly exposed to market discovery any moment now that the real economy and sustainable corporate earnings dwell in a region far below.

That the credit channel of monetary expansion is busted and done is patently obvious in the data on the household sector. Below is both the current track of total household debt since the December 2007 peak, and the prior Greenspan housing bubble track. The latter  turns out to be the last hurrah for the essential Keynesian “stimulus” gambit of the last several decades, which is to say, the one-time LBO of household balance sheets.

During the 78 months since the last peak, household credit has shrunk by 5%. Nothing like this has every happened before. Not even remotely close. And in truth, the relevant shrinkage has been even greater, since more than 100% of the slight up-tick in borrowing shown in the graph for recent quarters is owing to the explosion of student debt. By contrast, the traditional source of household “borrow and spend”—-mortgage borrowings and credit card debt—-is still below its 7-year ago peak.

Needless to say, this contrasts dramatically with the 78 month path after the 2001 cycle peak. During the Greenspan housing and credit bubble, household debt soared by nearly 90%, providing a robust, if temporary, boost to the consumption component of GDP.

The reason for the sharp difference in the most recent cycle is that Keynesian stimulus was always an economic trick, not an permanently repeatable exercise in enlightened monetary management. Quite simply, the US household balance sheets—-as measured by outstanding credit market debt relative to wage and salary income—got used up during the decades after the nation’s fiat money debt binge incepted at the time of Camp David in August 1971.

Now, in fact, the household leverage ratio has rolled over and is slowly retracing toward the still dramatically lower and more healthy levels that prevailed prior to 1971. In this context, it is surely the case that household leverage will continue to fall—-zero interest rates notwithstanding—– because it is a demographic given. The 10,000 baby boomers retiring each and every day between now and 2030 will not be adding to household debt; they will be liquidating it.

Household Leverage Ratio - Click to enlarge

Household Leverage Ratio – Click to enlarge

What this means is that the motor force of traditional Keynesian expansion is gone. Household consumption spending, perforce, can now grow no faster than household income and economic production, and likely even more slowly than that. The coming funding crisis of the social insurance entitlements—Medicare and Social Security—will surely jolt the American public into a realization that higher private savings will be essential to retirement survival. Accordingly, the household savings rate has nowhere to go but up in the years just ahead.

In any event, it is no mystery as to why business capital spending remains stuck on the flat-line. During the most recent quarter, real spending for plant and equipment was still 4% below its late 2007 peak——an outcome that is not even remotely comparable to the 10-25% surges that have occurred during comparable periods of prior business cycles.  Business is not rushing to the barricades to add to capacity because it is plainly evident that consumer demand is not growing at traditional recovery cycle rates; and that it will never again do so given the constraints of peak debt and the baby boom retirement cycle ahead.

As shown below, in fact, real net investment in CapEx—after allowance for depreciation of assets currently consumed—- is on a declining trend. Not only does this reflect the drastic downshift in the growth potential of the US economy that has set-in during the era of monetary central planning, but it also underscores that the current stock averages are capitalizing a future that is a pure chimera.

At 19.5X reported LTM earnings, the S&P 500 is at the tippy top of its historical range, and at the point that it has invariably stumbled into a deep correction. Yet why is it rational to capitalize at even historic average  PE multiples the earnings of an economy that is clearly locked into a low/no growth mode for as far as the eye can see? In truth, the market’s PE multiple should be well below the historic average generated during recent decades when Keynesian policy-makers were busy using up the nation’s balance sheets on a one-time basis in a nearly continuous campaign to stimulate credit-fueled growth.

Real Business Investment - Click to enlarge

At the end of the day, even the heavily massaged data from the Washington statistical mills cannot hide this reality. Setting aside the short-run inventory swings which cloud the headline GDP numbers each quarter, and which accounted for nearly half of the 4% gain reported for Q2, real final sales tell the true story. Notwithstanding the Fed massive balance sheet expansion since its first big rate cut in August 2007—-that is, from $800 billion to $4.4 trillion—–real final sales have grown at less than a 1% CAGR since then.

There is nothing like this tepid rate of trend growth for any comparable period in modern history. Indeed, given the clear bias toward under-reporting inflation in the BEAs GDP deflators, it is probable that during the last seven years the real economy has grown at a rate not far from zero.

All of this means that the financial markets are drastically over-capitalizing earnings and over-valuing all asset classes. So as the Fed and its central bank confederates around the world increasingly run out of excuses for extending the radical monetary experiments of the present era, even the gamblers will come to recognize who is really the Wile E Coyote in the piece.

Then they will panic.

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y3maxx's picture

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Stackers's picture

none of those graphs mean jack shit as long as M2 Velocity continues to plunge off a 60 year cliff. When and if M2 velocity "normalizes" ... watch out ! Until then, as Japan has proven, they can expand the money supply and subvert markets at will.

Chief Wonder Bread's picture

I keep having this fantasy that one day the Fedtards will wake up, have a 'Paul Volker moment' and allow the toilet to flush itself clean. Am I just a dreamer??

mayhem_korner's picture



Yes, you are dreaming.  Remember that the Fed is not the architect, it is the executor.  No one with a Volker gene in them would be allowed to work at the Fed at this juncture.

Eyeroller's picture

Ditto, you are a dreamer.

If the Fedtards "wake up" then they will have to admit to a $5 Trillon mistake, and accept the consequences.

The only thing the Fedtards can hope for at this point is a Black Swan, so when the crash happens, the blame can be deflected from the Fed.

Clesthenes's picture

“The only thing the Fedtards can hope for at this point is a Black Swan,”

Right on.

Will a Ron Paul Presidency be the Trigger for the Next Dark Age?  I used to tell people there was no chance that Ron Paul could even come close to winning the White House.  There are too many men in history who tried to reform governments who were eliminated by demonization, poison or banishment.  I thought that, if Ron Paul got anywhere near the White House, he would suffer one of these fates.

My thoughts about two of these possibilities (poison and banishment) are past tense.  I’ve had time to consider a wider perspective.  Now I think the criminal class look at Ron Paul as their man of the hour.

Or, more correctly, he could be ‘their scapegoat of the hour’.

When the crash occurs, nothing would profit bandit and useful-idiot classes more than to have Ron Paul in the White House, or just railing against the FR would be sufficient.  In this posture, the FR would find it convenient to blame him for the crash.  He didn’t believe hard enough in the wishful thinking policies of the FR; he, thus, caused millions of others to not believe hard enough.  And it all led to the crash.  And so, those who live by wishful thinking will turn their anger toward Ron Paul for their loss of jobs, houses, families, everything.  Ron Paul will become the scapegoat; and his “free market” ideals will likewise be demonized.  All this will give bandit and useful-idiot classes a free hand to preside over a New Dark Age, owing to huge governmental debt, that will last a thousand years, maybe five thousand.

jughead's picture

reminds me of the AIDS treatment I marketed for a while...a nice jar of HOT New Mexico green chiles.  Will it cure you? No, but it will make it painfully clear to you what your asshole was really made for.

PT's picture

Regarding the first link.  Obviously not many have seen this then (Shame about the excessive ads - I don't remember that bit but look here anyway ):

cchoo's picture

I started reading the creature from jekyll island and I am disgusted at where we are now...

Bastiat's picture

It just gets worse - but the truth is worth it.

SAT 800's picture

It's a very good post; it has the right time horizon; decades, and the right inflection point, the 1971 de-monetization of the "dollar"; and the beginning of the "spendathon". The statement about the GDP being zero for years is undoubtedly correct; the inflation-deflator is ridiculous and the increase in Govt. Spending as a percentage continuous; Govt. spending is not GDP; it's just wheel spinning. The de-insdustrialization subsequent to the Clinton puppet signing the most favored nation trade status legislation for China, and the concurrent propaganda storm for NAFTA; and globalization, was the start of the end-game. There will be no recovery. One of the most important indicators of world depressionary conditions is over-installed capacity. It's everywhere you look.

zaphod's picture

What's different this time is QE is tapering to 0 by Oct. 

Since 2009 every stock rise has matched QE injections and every stall has matched zero printing. 

These are not the dips to buy.


mayhem_korner's picture

What's different this time is QE is tapering to 0 by Oct.


LOL.  Good one. 

Even if the U.S. Fed were to stop its $45B/month by Oct, that doesn't mean that QE has tapered to 0.  It just means that the bankers will get there QE from the other CB junkies. 

Of the imaginable paths, the Fed tapering QE to 0 for any period time is among the least likely.  Unless they come up with a magical buyer of mis-priced debt, the ink will continue to flow.

lester1's picture

The FED is lying when they say they will raise interest rates. They cant without having people, businesses, and governments defaulting on their debts. Raising rates will also crash the "interest rates derivative" market causing the big banks to fail again..


Then who will save the economy when the FED is out of tools and credibility???

Bryan's picture

Everyone tacitly knows that, I think.  The consumers just did not increase consuming again when rates were held low and money was doled out to banks for lending.  The charade goes on because .... because they are out of bullets? 

Harbanger's picture

If the Fed has to chose between crushing the market or crushing the dollar, which do you think they would do?  They could just as easily chose to crash the market which would actually help the dollar.

Kilobar's picture

The Fed has no choice but to devalue the dollar in order to lower future unfunded liabilities. Unless we can get consistent GDP growth at around 6% year-on-year, inflation is the only answer. It's just a matter of time.

daveO's picture

6% YoY inflation sounds about right. ZIRP and 6% YoY inflation, a 'Bail In' by another name.

SAT 800's picture

or 10-12% inflation and capital controls, more anti-business regulations; in the end, the centrists always commit suicide. they have no more idea how to run an economy than my little sister does. the economy knows how to run an economy; if the government would just go away.

SAT 800's picture

Modern history shows that they will crush the dollar. They always do. it helps stem capital flight. De-valuation is the light at the end of the tunnel for them. your bet on Silver will pay off.

Kirk2NCC1701's picture

The FED is my Frenemy:  with Friends like that, who needs Enemies?

Let us pray:

The Fed is my Shylock, I shall want.

Yeah, though I travel through the valley of financial death, I will fear its evil.

It maketh me lie about greener pastures.

I shall live in the house of Ruin forever, and

I shall be miserable all the days of my life.

Shizzmoney's picture

Japan is the model.  They actually can keep this thing going on for 5-10 more years.

db51's picture

Whew....I was worried there for a then I should be past normal life expectancy and the monkey will be on my Grandkids.   Sweet.

mayhem_korner's picture



The yen is not the world's reserve currency.  Japan has been allowed to do it because it has been holding $1T of US Treasuries.

Kirk2NCC1701's picture

Yup... You hold their Bag (of Treasuries/Usuries), they hold your bag (of Treasuries/Usuries).

IOW... The Double-Bagger society: If theirs falls off, you hope that yours stays on. 

Bad-a-bing, bad-a-boom!

Kirk2NCC1701's picture

p.s. The Double-Bagger Society metaphor conjured up an image from the movie 'Eyes Wide Shut'...


1. TPTB decide who does the screwing, and who gets screwed.

2. If someone's mask comes off, you hope that your stays on, since you're the Outsider also.

yogibear's picture

Japan is the US Federal Reserve's grand Keynesian experiment.

Massive printing and eventual currency devaluation. 

PT's picture

I thought the housing market was overpriced in 2002.  Yes, we did have a little crash in 2008 but I've still been wrong for 12 years.

Dr. Engali's picture

Sorry David, but the fed has no choice but to continue this manetary madness. If they stop now it all collapses and then they have no tool left. No Dvaid they will not stop, what the need is an excuse..... like a war.... or a virus. 

Dr. Engali's picture

I'm buying. By the way thanks for locking me up before I could fix my dyslexia.

db51's picture

No need to panic.  Is it 3:30 yet?

buzzsaw99's picture

Looks like somebody doesn't have your back anymore. [/Satan]

what's that smell's picture

great movie! kudos for the clip.

The Phallic Crusader's picture

Ah, buying the dips - the strategy that works until it doesn't.

The reason for the sharp difference in the most recent cycle is that Keynesian stimulus was always an economic trick, not an permanently repeatable exercise in enlightened monetary management.

Yes! Thank you - you know, maybe sometimes accountants have better insights than economists...  the fact there are so many Krugmans in the Academy tells me, well first, they have a very skewed understanding of the history of the 1930s and 1940s - they conflate their political ideology with their historiopgraphy and, it seems, their economic analysis.

That is, unless you believe they are evil, rather than stupid {or ignorant}.  This shit isn't complicated...  fiat and frac reserve lending and interest and offshoring manufacturing and importing cheap labor and socializing losses while keeping profits and bonuses private...

Mix those elements in any amount you want, you still get an acid, eating away at the real, productive economy.

mayhem_korner's picture

maybe sometimes accountants have better insights than economists


You mean like abandoning mark-to-market to "save" the financial system from complete collapse in 2008/09?

Circle gets the square.

Spungo's picture

It's overpriced relative to cash, but it's not overpriced relative to monthly payments. Lower interest rates = higher asset prices.

mayhem_korner's picture



Artificially lower interest rates = artificially higher asset prices.  So much so, that things that are actually liabilities start to look like assets.

dynomutt's picture

The "Saving Rate" doesn't reflect real savings, only "savings" in fiat chips kept in klepto "banks"


OF COURSE the rate has gone down.

Ness.'s picture

The whole downside move retraced in minutes without any news.  Yes, they are still in control.  It's Friday guys and gals, we ALL know that we close Friday's in the green.  Oh well, yesterday was fun while it lasted.

DRT RD's picture

The guys over at are talking about the market, one said BTFD.  Thought, on my, this may be the Kennedy show shine moment!

oudinot's picture

Extremely well done article, thanks!!!