"Ineffective & Reckless" Fed Is An "Engine of Disaster"

Tyler Durden's picture

Excerpted from John Hussman's Weekly Market Comment,

The beauty of truth, and the beast of dogma

Other “relationships” that are used to justify activist monetary policy have similarly weak support when one actually takes the effort to examine the data. You’ll find a similar shotgun scatter of uncorrelated points if you plot unemployment versus general price inflation, for example. It’s unfortunate that the Federal Reserve is actually allowed and even encouraged to impose massive distortions on the U.S. economy based on relationships that are indistinguishable from someone sneezing on a sheet of graph paper.

We do know one thing very clearly, and we should have learned it during the housing bubble – suppressed interest rates encourage yield-seeking speculation, enable low-quality creditors access to the capital markets, direct scarce savings toward unproductive malinvestment, subsidize leveraged carry-trades, and unleash a whole host of “structured” products “engineered” by financial institutions to directly or indirectly piggyback on the good faith and credit of Uncle Sam.

When you examine historical data and estimate actual correlations and effect sizes, the dogmatic belief that the Fed can “fine tune” anything in the economy is utter hogwash. At the same time, the demonstrated ability of the Fed to provoke yield-seeking speculation and malinvestment is as clear as day. An activist Federal Reserve is an engine of disaster and little more. Even with the best intentions, a dogmatic Fed, unrestrained by reasonable rules and constraints, is a reckless and deceptive beast, constantly offering to heal the nation with precisely the same actions that inflicted the wounds in the first place.

Truth, on the other hand, is beautiful. Economic relationships that are supported in real-world data are a sight to behold. You want to see some relationships you can count on? The chart below shows the relationship between the 3-month Treasury bill and the ratio of the monetary base (currency and bank reserves) to nominal GDP, in data since 1929. Notice something. Without paying banks interest to hold excess reserves idle in the banking system, the Fed could reduce its balance sheet by more than one-third (over $1.4 trillion) without pushing short-term interest rates above zero. That excess base money does nothing to support the real economy.

Nobody’s desired level of saving, consumption, or real investment changes just because the Fed has chosen to force the economy to hold more base money and fewer Treasury bonds. But somebody has to hold that cash at every point in time – and nobody wants to hold it. So it simply acts as a hot potato, encouraging yield-seeking speculation in the financial markets. In my view, the most urgent action the Federal Reserve should take is to cease reinvestment of principal as the holdings on its balance sheet mature, in order to reduce this massive pool of idle base money, which does nothing but to promote speculation. No increase in interest rates would need to result from that action.

...

After years of speculation, we currently estimate a 10-year nominal expected total return for the S&P 500 close to zero – much the same as we projected in real time at the market peak in 2000. The Federal Reserve seems to have no idea what it has done. Poor long-term market returns and severe interim losses are now baked in the cake as a result of obscene valuations. There is no way to undo this outcome – only to manage the consequences.

With regard to a possible quarter-point hike this week in the amount of interest that the Fed pays banks on idle excess reserves, our view – frankly – is that it doesn’t matter. From a longer-term standpoint, poor stock market returns and the likelihood of 40-55% market losses from the recent peak are already baked in the cake.

Across the pond, our friend Albert Edwards at SocGen strikes the right note, I think:

“The clamour for the Fed not to enact the long-awaited ¼% rate hike next week is growing by the day. Misgivings come not just from reputable mainstream commentators, but now also the World Bank has repeated the IMF’s recent words of caution in advising delay. What a load of nonsense! My esteemed colleague Kit Juckes characterizes the current consensus thinking as ‘If the Fed hikes, pestilence, plague and never-ending deflation will follow.’ Well even those like me who see a deflationary bust awaiting think the Fed should hike next week – because the longer you leave it, the bigger the financial market excesses become, and the bigger the risk of financial dislocation and global recession ensuing. Have we learned nothing from the 2008 Great Recession? Just get on with it!”

...

The real problem isn’t what the Fed may do, but the ultimately unavoidable consequences of what the Fed has already done. The cost of reckless Fed-induced yield seeking will likely be felt first in the financial markets as previous paper gains evaporate, while defaults on excessive low-quality covenant-lite credit will emerge over the course of the economic cycle, and the impact of malinvestment will be to limit productivity and economic growth over the longer run. This is all rather inevitable except in the eyes of those who haven’t watched and memorized a dozen adaptations of the same movie.

Again, as I noted in The Line Between Rational Speculation and Market Collapse, investors should remember that the Fed did not tighten in 1929, but instead began cutting interest rates on February 11, 1930 – nearly two and a half years before the market bottomed. The Fed cut rates on January 3, 2001 just as a two-year bear market collapse was starting, and kept cutting all the way down. The Fed cut the federal funds rate on September 18, 2007 – several weeks before the top of the market, and kept cutting all the way down.

 

“What will matter significantly for investors is the condition of market internals, credit spreads, and other risk-sensitive measures in the event that U.S. economic activity begins to further reflect the downturn that is already evident abroad. It is that evidence of investor risk-preferences that will determine the proper response to any change in Fed policy.”

In short, my view is that activist Fed policy is both ineffective and reckless (and the historical data bears this out), and that the Federal Reserve has pushed the financial markets to a precipice from which no gentle retreat is ultimately likely. Similar precipices, such as 1929 and 2000, and even lesser precipices like 1906, 1937, 1973 and 2007 have always had unfortunate endings (see All Their Eggs in Janet’s Basket for a review). A quarter-point hike will not cause anything. The causes are already baked in the cake. A rate hike may be a trigger with respect to timing, but that’s all. History suggests we should place our attention on valuations and market internals in any event.

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stant's picture

No more 72 hookers and blow for the jihadist bankers

Fun Facts's picture

The privately owned Federal Reserve Corporation was established in Secret in 1913 by Rothschild agent Paul Warburg who bribed the politico [and who later founded the Council on Foreign relations] for the sole purpose of usurping the wealth of the world [creating a global serfdom] for the exclusive benefit of Rothschild syndicate [BIS,EU,IMF,FED,World Bank] shareholders.

Read the protocols for extra credit.

Supernova Born's picture

Money printers making their cronies rich and everyone else their wage serf.

 

adr's picture

Oooh I hate the FED, with thier wee beady eyes and that smug look on their faces.

Come on how can you hate the FED.

BECAUSE THEY DEBASE THE DOLLAR AND DESTROY YOUR PURCHASING POWER... SMART ASS!

............

 

There isn't anything more that we can do. Wall Street is now the economy. The only corporations that are started are those that can scam the mechanism. Commerce is dependent on publicly traded vendors, publicly traded retailers, and publicly traded banks. You can't even get power most places unless you buy it from a publicly traded paper pushing contract flipper.

Either it all ends and we rebuild, or we continue to slowly decay. Currently the world is voting for slow decay. Those is power hope they will all be dead before the building collapses.

luna_man's picture

 

 

I'm down with Ron P....AUDIT the Fed.

 

watch them CRIMINAL rat's scurry

earleflorida's picture

whether a rate hike or, 'a-steady-as-we-go' scenario is posited ... the market will sell-off on the negativity of a caprice reality now coalescing

Redart's picture

Relax and keep calm. Everythings gonna be alright. Just buy the dips and relax

GRDguy's picture

"Ineffective and reckless???"  Destroying a country and profiting from that, at the same time, has been their plan since the Fed was created. When dealing with sociopaths, you must watch their actions rather than listen to their words.  Any chart of the value of the dollar since 1913 pretty much goes from the northwest corner to the southeast corner, as if a ship sailed.  Never in a straight line, but still getting to the desired destination. We are the ones ineffective to stop them, and ignoring their skill is certainly reckless. No different from a smart neighborhood bully that no one stands up to.

A Lunatic's picture

It's the FED stupid. This we know. Nobody gives a fuck enough to end it. This we also know.....

Clowns on Acid's picture

The Fed and Banks knew this on Day 1. The objective was to save then enrich the Banks. Period.

Why all the chicken lip flapping by authors on how bad the Fed deciosn to print money to Banks was? We all know what was going to happen.

Lets have some articles on how to clawback privitized profits from nationaized monetary printing !!

 

Md4's picture

When you examine historical data and estimate actual correlations and effect sizes, the dogmatic belief that the Fed can “fine tune” anything in the economy is utter hogwash. At the same time, the demonstrated ability of the Fed to provoke yield-seeking speculation and malinvestment is as clear as day. An activist Federal Reserve is an engine of disaster and little more. Even with the best intentions, a dogmatic Fed, unrestrained by reasonable rules and constraints, is a reckless and deceptive beast, constantly offering to heal the nation with precisely the same actions that inflicted the wounds in the first place."

Been pounding this like a judges gavel...

Soon, maybe the affected masses will start pounding Congress to get rid of the Fed.

In fact, I was thinking about what a "U.S. Treasury Note" would look like today...no central bank involved...

m

El Hosel's picture

The Fed represents the machine, the machine eats whatever it wants, they all fart in your general direction.

Phillyguy's picture

Since the 2008 financial crash, central banks (US FED, BOJ and ECB) have pumped large amounts of cheap money (QE) into (still) insolvent banks. Where has all of this money gone? It has inflated asset (real estate and equities) prices and disrupted emerging market economies (collapsing commodity prices). Stock prices have been further propped up by company stock buy-backs (reduces number or outstanding shares, driving prices up) and Central bank intervention (directly buy shares), using QE- supplied cheap money. Thus, no one knows the “real” price of these assets, because they have been completely distorted by QE. This is one of the reasons stock prices are fluctuating wildly ("volatility").