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The Blindingly Simple Reason Why The Fed Is About To Engage In Policy Error
Two weeks ago, when deciphering the FOMC's latest minutes, the market surged after paying particularly close attention to an extended Fed discussion of a heretofore little known aspect of the Fed's monetary policy decisionmaking, namely its focus on r*, or the "equilibrium" growth rate.
As Goldman then summarized, "minutes from the October 27-28 FOMC meeting indicated that most FOMC participants thought that the conditions for liftoff "could well be met by the time of the next meeting.” The minutes also noted staff estimates that the short-run equilibrium real interest rate is currently around zero and the long-run equilibrium rate would likely remain lower than was the case in previous decades."
For those unfamiliar, the equilibrium growth rate is roughly coincident with the Fed's long-term inflation goal which over the past several decades has been around 2%. However, as a result of secular stagnation even the Fed has been forced to admit that not only is US potential growth lower, but so is r*, or the equilibrium growth rate.
This is what Deutsche Bank said recently, when explaining the Fed's rush to hike rates:
The logic for reducing accommodation is embedded in a cyclical view of the economy that defines a real rate equilibrium in the short term with a long rate equilibrium anchor based on price stability defined around 2 percent. There is a presumption that inflation is naturally pulled towards a 2 percent “long run” equilibrium as long as the economy grows above potential. And there is a presumption that if the actual real rate is below the short-run equilibrium rate, then growth will be above potential. The fundamental question is whether the underlying inflation equilibrium is actually 2 percent or lower. If for example we have been growing above potential for a while, then maybe inflation is also exaggerated higher now.
The reason why the Fed's latest Minutes resulted in a jump in the market is because if indeed r* is around zero or well below 2%, then the Fed's rate hiking cycle will be very quick before the Fed is forced to abort it and resume easing: perhaps as low as 3 rate hikes tops before r* is hit and the economy can not sustain any more tightening.
As Goldman summarized the Fed's thinking on this matter, "participants also noted that the lower long-run equilibrium rate implies that the near-zero effective lower bound could become binding more frequently. As a result, “several” participants indicated that it would be “prudent” to consider “options for providing additional monetary policy accommodation” should the economic recovery falter."
Well, yes, by now it is no secret that the Fed is only hiking so it has dry powder to easy in the coming quarters when the US recession can no longer b ignored by the NBER and various tenured economists.
But, as Deustche Bank took the question one step further, what if r* is already negative? In that case, the Fed should be easing, not hiking, and any tightening in financial conditions would mean a policy error.
Here is Dominic Konstam with this troubling line of inquiry:
Even if the equilibrium real rate does not change, the Fed might at least be able to get to the market’s view of the terminal rate – slightly below 2 ½ percent – without inflicting serious damage on the economy. If the equilibrium real rate does rise, all the better – the markets would move to the Fed’s dots, and the terminal rate would be around the Fed’s target of 3 ½ percent.
The alternative view is more worrying. In this view, the equilibrium nominal rate is at present much lower than the Fed thinks and the equilibrium real rate is meaningfully negative. Policy at present is not very accommodative, and to the extent that it is, inflation is actually running above its equilibrium level, which is close to 1 percent.
And here, the Deutsche Banker does something no other economist has considered: assume that the US long-rate growth rate is curbed by something as simple as massive amounts of debt. To be sure, debt is something the US has loads off. As we reported two months ago, following the recent revision to the Fed's Flow of Funds report, total debt/gdp was "revised" from 330% to 350%.
How should this figure into the Fed's equilibrium rate calculus? It's actually very simple. Cue Deutsche Bank:
One might argue for low “implied” equilibrium short rates via debt ratios. For example, if nominal growth is 3 percent and the debt GDP ratio is 300 percent, the implied equilibrium nominal rates is around 1 percent. This is because at 1% rates, 100% of GDP growth is necessary to service interest costs.
In this case, real growth would slow in response to rate hikes because productivity would stay weak at full employment and companies would be profit/price constrained around paying higher wages. Moreover, nominal growth would then slow even more than real growth does because inflation would fall to 1 percent or below.
Wait, growth is limited due to 350% (sorry, it's not 300% any more) in cumulative debt/GDP as a result of which all "growth" is being used to pay down interest expense? Now how did not a single Fed economist think of that? Oh yes, because it is so blidningly obvious!
Which brings us to DB's punchline:
This is the important policy error scenario because even a very shallow path of rate hikes might drive the real Funds rate well above the short-term equilibrium real rate, further depressing demand. It is then plausible that the economy would be driven into recession, and the Fed would quickly be forced to abort the hiking cycle. As an aside, such a policy error could reinforce itself by causing structural damage that puts additional downward pressure on the equilibrium real rate. In this case the yield curve would flatten meaningfully, at least until the Fed actually reversed course by cutting rates.
In summary, a rate would lead to the proverbial cats and dogs, living together, mass hysteria, etc., but on the condition that r* is indeed far lower than the Fed thinks it is.
So to help the Fed and pundits calculate just where r* is in an economy where total debt/GDP is 350% and rising, and where GDP is 2% and falling, we present a sensitivity table which looks at just two simple variables: nominal growth, or GDP, and total debt/GDP. Assuming the current leverage of the US and assuming 2% in nominal growth, the short-run equilibrium real interest rate is just about 0.57%.
In other words, two rate hikes... and the Fed will have no choice but to cut rates all over again.
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The "policy error" will be a 0.25% head fake rate rise, instead of 5% and getting the hell out of the way.
The Fed is pricing money at zero. Let's properly identify what this "rate" really means: It means the US note is worth nothing. Interest is not the rate that you pay as we were all taught, interest is the price of the dollar borrowed. They are pricing their own fiat note at NOTHING.
End the Fed and ALL western financial repression ends.
I'm just glad ZH has stopped posting those inane 'Marc to Market' articles. That guy was really lost.
This is interesting theory, but interest is cost of dollar over time, not include principal. So ZIRP is only mean dollar tomorrow is no than is dollar today, so ZIRP is anticipate no economic growth and surprise, surprise, surprise, economy is not grow for 6 or 7 year during ZIRP or NIRP program of Central Bankster.
Exponential Growth Function Is A Bitch:
[At a continuous] 2.3% growth rate, we would be using energy at a rate corresponding to the total solar input striking Earth in a little over 400 years. We would consume something comparable to the entire sun in 1400 years from now. By 2500 years, we would use energy at the rate of the entire Milky Way galaxy—100 billion stars! I think you can see the absurdity of continued energy growth. 2500 years is not that long, from a historical perspective. We know what we were doing 2500 years
Link – A must read for science nerds
History will show this was a crazy time period. r* says we need lower interest rates? If it sounds too complicated to understand, chances are the goal is to confuse not enlighten.
ZIRP is intended to fund the federal government at the expense of savers. Borrowing is a replacement for other taxes that so many object to. Borrowing is stealth tax that is not drawing so much objection.
Tax by any other name still slows the economy. I understand saving is the engine of grow. Taxing savings by ZIRP has got to be super pernicious.
This is not complicated. If you want growth encourage saving. Let saviers have some reward. Accepting r* goobledy gook, that savers should be punished, is crazy.
Growth at 2%? That's pretty iffy, which means .57% is being generous. They'll hike one week and one emergency meeting later they'll backtrack and go the NIRP route.
About to Engage in policy error?
What have they been doing right the past 20 years?
...since 1913 more like it.
This post seems adapted from the Middle Age discussions about how many angels could stand on the head of a pin.
r* ??? WTF
"Equilibrium interest rate" based on how much interest has to be paid on the debt?!!!!!!
You've got to be kidding!!!!
Do you expect anyone with more than one brain cell to believe this sh.t?
Try this simple class in economics:
1. Capital = Production - Consumption
2. The price of capital is the interest rate
3. Prices are set by supply and demand
4. Gold is money, everything else is credit.
Then abolish the Federal Reserve system.
And by the way, fu.k you and all of your financial criminals buddies.
Remind me where those interest payments go? Oh right. The U.S. borrows, the Fed issues the debt.
a system so crazy people simply can't believe it.
Damn, ain't that the truth. I clearly remember listening to my uncle, who worked in finance, rant for hours and thinking, "That CAN'T be right." Imagine my surprise when I discovered it was indeed much much worse.
One day I hope I do not have to ever say this again but for now.. END THE FED!!
They built a house of straw. The thundering machines sputtered and stopped. Their leaders talked and talked and talked. But nothing could stem the avalanche. Their world crumbled. The cities exploded. A whirlwind of looting, a firestorm of fear. Men began to feed on men.
On the roads it was a white line nightmare. Only those mobile enough to scavenge, brutal enough to pillage would survive. The gangs took over the highways, ready to wage war for a tank of juice. And in this maelstrom of decay, ordinary men were battered and smashed.
Except for one man armed with an AK-47, and a Honda full of silver.
Yeah. And the Kenyan in the white house and wicked witch hillary wants to take away your AK-47.
But all will be OK if they can keep the Mapah Bakon flowing. LOL
FCisms.
when shit really hits the fan, and men are eating men, you can bet your ass I am not wasting my energy carting any silver around
>that the short-run equilibrium real interest rate
>is currently around zero and the long-run equilibrium
>rate would likely remain lower than was the case in
>previous decades
What kind of gibberish is this supposed to be?
By that logic in any recession the "equilibrium" rate would be negative, but anyone with a brain knows you can't have that. The error is in thinking the rate can be calculated dynamically. In reality as rates approach zero all sorts of crap breaks down. Like now.
This economy has structural problems, and there is no number on the dial that fixes them. The least the Fed can do is restore stability the monetary world, not pretend to whip the stubborn mule with a wet noodle of monetary moves.
Errors occur when the outcome of your action is not what you intended.
Thus this is not a policy error but the checking off of a waypoint on a journey that was never mentioned but always intentioned.
The Fed is going to lift rates next week...
I bought gold contracts @ 1055 area.
All hell is going to break loose, and commodities are going to rise again.
We currency traders, are even smarter then bond traders.
I agree they are going to raise rates. I disagree that gold is going up in the short-term. They still have control over the paper market. But I have no money where my mouth is short-term because I've been burned too many times trying to trade PMs (just holding physical at this point), and hope you're right.
My trades have "trailing stops", and are well in the money.
Yes, Rand, my trades are purely speculative, and I would recommend that traders stay flat/square until after the holidays.
GOLD
You have bigger balls than me. Good luck.
" trailing stops"
Short term "bull flag".
The trade will be long gone before the Fed. next week. ;-)
I have some long stock on gold and silver miners, really crap now but they are cheap.
Someday they might skyrocket, but if not I lost a few hundred, I am good at that LMAO
I'm long PAAS, which I bought the last time the PM market couldn't go any lower. Another burn, but they do pay dividends so I've got that going for me.
Same here. If they fall further I'll just buy more. They will absolutely go through the roof when gold takes off. Miners have literally 'never' been this cheap.
Over what term are commodities going to rise again? IMO as USD goes parabolic with rate hike, commodities drop in the near term until the pair reverses and USD plummets... thoughts?
I agree that commodities rise again, but not with the rate hike... it's a subsequent event that does it.
Yen man. Going long gold for the long term?
Yen man Going to loose shirt. Good thing you put stops in.
No disrespect. Gold will be going up a bit more for the near short term and then dive after that.
What part of "trailing stops", did you miss?
Everything UNDER the little red-line is profit.
JFC, open a practice account, so you don't look like some idiotic financial illiterate.
Here's a linkhttp://www.fxpro.co.uk/ You're welcome.
Actually in my experience (25 years in the markets) fx traders are only marginally above equity traders in terms of "smarts". They are certinly no where near bond traders!
And btw, generally commodities do poorly as the USD rises, but i guess you being one of those smart fx punters you already knew that....
Other than fuel prices are up. Go to CostCo or Target. I get canned food for the cats, was $17.99 now 19.99. Target brand trisquits were 1.79 now 2.09. No Inflation? Sure if you are buying washing machines. Food and other items are way up. Cheapp shit from China is still cheap, sure, the chinks are blowing their over capacity from their slaves and dirt cheap freight shipping for all it is worth. But in the real world for people who buy food and necessities prices are up 10-15%.
Wages and wage growth are in the toilet. Unemployment numbers are beyond fake.
And here in NZ the worst inflation is directly caused by the govt, Rates (land taxes), fees, licenses, tickets and fines, tuition, etc. Any dealings with local or national govt has gone up 6 to 8% in the past 12 months.
don't care
Hahahaha... that's the spirit.
People actually still believe this is a real economy and real market... looking at all of these charts is almost a joke after a while... for example, how accurate are GDP calculations? How can they possibly be 100% accurate, its just a way for TPTB to micro manage everything
So what's the fix? negative rates - another stealth tax on workers so that "the economy" [debt payments to banks] can improve?
Sure, why not.
Anyone know any good real estate agents in Costa Rica?
Actually, yes... how about San Juan del Sur, Nicaragua?
The fix? First we have to understand what a derivative is ..
That is in the context of a credit worthy bank and U.N. (United Nations) Contract #4 ..
The concept of the derivative did not exist before Contract #4. There was no need for a derivative (mother of all ponzies) prior to C - #4 ..
https://app.box.com/s/hfgvcqg7gqh7i27at6sv53ywu87lwarp
Go directly to Wanta interview #3 (3rd interview with Wanta Dec 19 2014.mp3)
The fix is bust the derivatives. There is no soft landing here. How can there be a soft landing in +Quad in derivatives? We going to wait a 100 years for the venom to be purged undetected? There is going to be some initial pain ..
My long treasuries will keep paying interest and when there is a flight to safety or the FED starts QE again, then I will have another HUGE capital gain.
I am in AWE at how much capital gain I already have on my treasury portfolio - anytime I want a little high, I just look at my brokerage gains position - love it!!! :-))
It's the trade of a generation until it's not.
Although if rates ever start going up that will be the reverse o matio on your capital gains and while you can hold to maturity that implies the dollars they represent when they mature will be worth as much or more than a dollar today.
That is unlikely to be the case in the extreme at some point in time but again timing is everything so good luck.
No worries. Whatever happens, the Fed will continue to buy stocks covertly to prop up the market and prevent investors from bailing.
Audit the Fed !
When you see cars being sold with 75 month 0% apr loans, you should assume the FED is doing something very, very wrong.
One of the underlying problems is that the global monetary system has failed with too much debt in existence.
No one can see it because no one understands it, the knowledge has been lost.
The current monetary system has the following characteristics:
1) It is debt based, new money can only be created from new debt
2) It uses compound interest
Compound interest is an exponential function that, without prudent lending, will run away to infinity at some point.
When money creation lies with banks, there is always the over-whelming desire to increase profits by lending out more than would be prudent (their profit comes from the interest received).
The temptation of jam today, makes borrowers forget about the penury tomorrow.
The system relies on prudent lending by bankers who are purveyors of the debt products, e.g. loans, mortgages, etc ...
The temptation to increase profits though increasing interest payments and debt was too much and they developed ways to take no responsibility for repayment of loans through things like securitisation and complex financial instruments. In the sub-prime fiasco we saw NINA (no income, no asset) loans as no one cared if the money got paid back.
Individual players can post profits and collect bonuses by issuing bad debt but their actions together will bring down the debt based monetary system as the compound interest repayments overwhelm the system.
For the last seven years we have seen rock bottom interest rates, the last ditch attempt to keep the compound interest mounting up under control.
For all intents and purposes the global monetary system has failed already, the FED rate rise will show us once and for all if we really have maxed. out on debt and cannot take even a 0.25% rate increase.
If you want to understand money and acquire the knowledge that has been lost:
Beginner:
https://www.hiddensecretsofmoney.com/videos/episode-4
Steve Forbes – Editor in Chief of Forbes Magazine endorses this video (can be seen at the end) so it has very good credentials.
Intermediate:
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneyintro.pdf
http://www.bankofengland.co.uk/publications/Documents/quarterlybulletin/2014/qb14q1prereleasemoneycreation.pdf
Advanced:
“Where does money come from” available from Amazon
Bankers having trouble with prudent lending ……
“What is wrong with lending more money into the Chinese stock market?” Chinese banker recently
“What is wrong with lending more money into real estate?” Chinese banker last year
“What is wrong with lending more money to Greece?” European banker pre-2010
“What is wrong with a NINA (no income no asset) mortgage?” US banker pre-2008
“What is wrong with lending more money into real estate?” US banker pre-2008
“What is wrong with lending more money into real estate?” Irish banker pre-2008
“What is wrong with lending more money into real estate?” Spanish banker pre-2008
“What is wrong with lending more money into real estate?” Japanese banker pre-1989
“What is wrong with lending more money into real estate?” UK banker pre-1989
“What is wrong with lending more money into the US stock market?” US banker pre-1929
It’s a global problem.
So, why is some Bankster stuge down voting you?
A video showing how monetary systems constantly fail and are replaced by new ones.
The problem is always debasing the currency. Mixing gold/silver coins with other metals, clipping gold/silver coins and today massive monetary expansion through bank loans and money printing by central banks.
The idea this time was that Central Banks would make the difficult decisions as politicians always started money printing to bribe voters.
From the video below this is not the real problem, they go into out of control money printing to fund war which is very expensive. Today we can see the US military in action around the world and the Dollar is the global reserve currency.
The Central Bankers that were supposed to make the difficult decisions went into wild money printing mode when the banks screwed up in 2008, rather than forcing them to accept the creative, destruction of Capitalism.
The crisis was of such magnitude that steps were needed to wind down the failing institutions in an organised manner but they decided just to keep the failed system on the road with little reorganisation.
Japan did the same after 1989 and the results have been the same too, no real collapse, no real growth just stagnation as the problems are put into suspended animation.
When you can print money, the temptation to do it is always too great, no matter who looks after the printing press.
The global monetary system has been in decline for over a century with each major change being forced by war. In 1971, all ties to a sound base (gold/silver) were cut, money has since then been pure fiat and ready for massive monetary expansion that eventually took place in the great financial revolution of the last decades.
https://www.hiddensecretsofmoney.com/videos/episode-2
A new monetary system is now due.
I am not a professional economist or otherwise financial specialist and sometimes I really struggle to understand mountains of jargon and nebulous concepts like r* equilibrium growth rates.
As far as I can figure out this article means if you have intergalactic shitloads of debt then an interest rate rise is not very welcome. Well who'da thunk.
Yes, all these bankers missed it. Whatever.
If bankers are NOT one thing, it's dumb. These folks are extremely smart and worse sinister. Bankers do not view the world through "middle class eyes".
The real question is, what is the hidden agenda of bankers? big gubbamint?
Was it really as simple as Yellen paving "perceived stability" for Obama and when Obama leaves the world tanks??? Or is it worse?
Sure looks like worse - Obama is going to spend his final year watching the global economy tank - not what the communist ordered.
Don't worry....
Everything is Awesome!
Ah yes, the cries from the banking fraternity now of "please don't hike rates, else how can we ramp equities into year end to ensure our bonuses?" Please....now they chuck every excuse up for not hiking. Even if growth is slowing they StILL should be hiking and getting away from this ridiculous zero bound. So some companies will fail, maybe even some banks, who cares. Let the system clear itself out and stop artificially influencing capital allocation by distorting the real price of assets.
This article is like the weather, people like to talk about it a lot but if you look out the window it says it all. "r*" gimmi a* break.
It is not error. It is intentional. https://www.oathkeepers.org/8722-2/
The real take-away point is this- there is either going to have to be a massive price inflation that risks currency death, or there is going to have to be a massive debt default cycle.