Are We Headed For Another Bust?
Submitted by Frank Shostak via The Mises Institute,
On Wednesday December 16, 2015, Federal Reserve Bank policymakers raised the federal funds rate target by 0.25 percent to 0.5 percent for the first time since December 2008. There is the possibility that the target could be lifted gradually to 1.25 percent by December next year.
Fed policymakers have justified this increase with the view that the economy is strong enough and can stand on its own feet. “The Committee judges that there has been considerable improvement in labor market conditions this year, and it is reasonably confident the inflation will rise over the medium term to its 2 percent objective,” the Fed said in its policy statement.
Unwarranted Optimism
Various key economic indicators such as industrial production don’t support this optimism. The yearly growth rate of production fell to minus 1.2 percent in November versus 4.5 percent in November last year. According to our model the yearly growth rate could fall to minus 3.4 percent by August.
Although the yearly growth rate of the CPI rose to 0.5 percent in November from 0.2 percent in October according to our model the CPI growth rate is likely to visibly weaken.
The yearly growth rate is forecast to fall to minus 0.1 percent by April before stabilizing at 0.1 percent by December next year.
So from this perspective Fed policymakers did not have much of a case to tighten their stance.
Fed policymakers seem to be of the view that the almost zero federal funds rate and their massive monetary pumping has cured the economy, which now seems to be approaching a path of stable economic growth and price stability, so it is held.
With this way of thinking the role of monetary policy is to make sure that the economy is kept at the “correct path” over time.
Following in Greenspan’s Footsteps
Deviations from the “correct path,” it is held, occur on account of various shocks, which are often seen as a mysterious nature. We suggest that the present Fed is following the footpath of Greenspan’s Fed, which was instrumental in setting in motion the 2008 economic crisis.
An important factor behind the 2008 economic crisis was the previous loose monetary stance of the Fed, headed at the time by Alan Greenspan. The federal funds rate target was lowered from 6.5 percent in December 2000 to 1 percent by May 2004.
This massive lowering of interest rates was instrumental in triggering the economic boom that followed, in particular in the real estate market. Also, the then Fed policymakers were arguing that the aggressive lowering of interest rates was necessary to stabilize the economy, i.e., to bring it on the “right path.”
By June 2004, Fed policymakers had reached the conclusion that the economy didn’t require more help from the Fed and could stand on its own feet. Consequently, the central bank lifted the federal funds rate target by 0.25 percent in June 2004 to 1.25 percent. The Fed adopted a policy of a gradual tightening of interest rates until June 2006. Note that by June 2006 the target was set at 5.25 percent and was kept at that level until August 2007.
The 2008 Crisis Exposed the Problems of Fed Policy
The Fed’s view at the time was that a gradual tightening (each time by 0.25 percent) of the interest rate stance would prevent the unnecessary disruptions and would permit Fed policymakers to navigate the economy more accurately toward a path of stable economic growth and stable prices. The economic crisis of 2008 shattered all that.
Yet, manipulations by the Fed could not bring the economy onto a path of stability and prosperity but, on the contrary, set in motion the menace of the boom-bust cycle.
The Boom Creates the Bust
By means of an artificial lowering of interest rates the central bank gives rise to various activities that cannot support themselves without the easy monetary stance of the central bank.
The lower interest rate stance, which is also accompanied by increases in the money supply growth, sets in motion the diversion of real wealth from wealth generators to various nonproductive or bubble activities. (These activities cannot support themselves and couldn’t have emerged in a free market environment.)
The emerging economic boom, which is falsely labeled as an economic prosperity, leads to the weakening of the wealth generation process.
At some stage the central bank, which follows various economic indicators to justify interest rate manipulations, reaches the conclusion that the economy is starting to deviate from the “correct path.”
Consequently the loose interest rate stance is reversed. This begins to undermine the survival of various bubble activities — an economic bust ensues.
The magnitude of the bust is influenced by the extent of the previous loose monetary stance and by the state of the pool of real wealth. (Note that what permits economic growth is the pool of real wealth which funds economic activities.)
Now, if the pool of real wealth is stagnating or shrinking, then regardless of the Fed’s policy, the economy can’t show a general economic growth.
A tighter interest rate stance coupled with a shrinking pool of real wealth will not only undermine bubble activities but also good activities, which couldn’t be introduced on account of the lack of real funding.
As time goes by though a tighter stance will eliminate bubble activities and will leave more real wealth at the disposal of wealth generators and will permit the introduction of various wealth generating activities.
The prolonged low interest rate policy of the Fed, on top of the Fed’s previous loose monetary policies (during Greenspan’s era), has severely weakened the pool of real wealth, which is currently in a dire state.
This raises the likelihood that the elimination of bubbles as a result of a tighter stance while good in the long-term for wealth generators is likely to trigger a severe economic slump in the near to medium term.
(4 votes)
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The Fed interjects $3b into equity at yesterdays close, China buys $20b, who knows what the ECB and BoJ did, and stocks remain flat. Yeah, I would say bust like Anna Nicole Smith.
They propping up this fake economy until Obama's term is over, at any cost. It's all politics.
Is CNN covering for Hillary over UFO investigation pledge?
http://tinyurl.com/jlobpbm
Does the Pope shit in the woods?
The central banks aren't getting any ROI. Holding it up for another year is going to cost hundreds of trillions of dollars and . This will create a shitstorm in currency markets. Africa, as a continent, is already diving into hyperinflation. This will end sooner than you think.
As much as I am not a fan of the Fed I'm going to stand up for them on this one. Apparently the wealth affect and manipulated employment and growth numbers say we are not in a recession...but who is in charge of manipulating those numbers? Not the Fed. Secondly the fed lowered rates and pumped trillions of dollars inot our economy, but the big problem wasn't the Fed policies of ZIRP and QE, the big problem was the banking policy which decided where that money went. Again, this is not the Fed's fault. Our government has totally abaondoned ship. Rather than reign in excesses of TBTF banks they let them become larger and more systemically dangerous. Rather than enacting the Volker rule which would have made the derivatives market much more transparent, they let it fail. With its failure the TBTF banks can continue to create and sell 'crap' exotic financial instruments and make huge sums of money in the process. If our government had enacted policy that funneled money to Main Street instead of their rich buddies we might be singing a different tune.
Yes, I may not like the Fed, but the government is primarily responsible for where we are today. They created the policy and relaxed environment that led to the meltdown and are repeating the story today. Let's vote these fuckers out and get some peeps in office who will do the right thing for the people, not just their rich buddies.
So handing trillions of dollars over to evil banking houses such as JP Morgan - which stole hundreds of millions of dollars out of allocated accounts at MF Global - isn't even complacent yet malicious?
Laughable.
I agree...but we had to do something...injecting money nd lowering rates has worked to some extent but it would have worked a LOT better if governmental policy had been different. The 13 primary dealers and their people all got filthy rich from QE. And so did the beneficiaries...the TBTF banks. What we needed was a policy which forced mot of that money back into the economy and job creation, not into exotic financial instruments that benefited very few Wall Streeters immensely. That falls squarely on Obama and his administration. Tell me, why have the TBTF banks gotten bigger and more systemicall dangerous under his watch? Why have the rich become so much richer and whu has the wealth disparity grown to a record level under his watch. Isn't he supposed to be for th elittle guy? Why have their been no arrests or prosecutions of bankers as a result of the subprime meltdown? The answer is obvious for people who don't have their heads up their asses. (Btw, a great refernce book: 'Confidence Men' by Suskind).
"but who is in charge of manipulating those numbers? Not the Fed"
Stopped reading your post there...
We most certainly are. This phoney economy has bought a one way ticket into the dumps. There is no turning back at this point.
http://jimrickards.blogspot.ca/2016/01/rickards-on-helicopter-money-and-...
If Keynesian economics was so wonderful, why so much trouble managing and stabilizing it? Why? Because it has no viable mechanism for its main premise to last long term and survive. A solid economic system would be able to be managed and survive in BOTH directions, periods of growth as well as periods of regression. That is the system that exists in nature, and that is why we are here. The monetary system that's in place falls short of replicating what works in nature, so it will not survive, or at the very least, will migrate to a level where it barely does.
They rely on models to simulate reality and if model results differ from reality, then the model is wrong. With the Fed, climate change etc though, reality must be and will be ignored since it's obviously wrong.......
The Fed destroyed forever the illusion that their fiat currency regime had anything to do with the relationship between productive labour, physical assets, value and money.
Now we exist in a world where 'money' has been found out to be a phantom and only the dimwits still believe in it.
Janet just called to say all financial cycles have been cancelled until further notice.
she would know since the fed causes those "cycles"
Well, there's too many buybacks, I can't pass, no
So I tried my best illegal qe move
A big black and white come and crushed my groove again
Go on and write me up for trillion four point five
Post my face, wanted dead or alive...
Are we headed toward another bust?
This is a rhetorical question, right?
AS IF the hockeystick asset bubble since 2009 can be sustained by fiat printing and HFTs.
AS IF China's policy decision to move from and industrial to a consumer economy is not gonna tank commodity prices.
AS IF the commodity bust is not gonna tank the EMs into a deflationary cycle.
AS IF the tanking of the EMs is not going to effect the paper asset stawks and bonds, and tank the fantasy 2% inflation 'target' of the Fed.
AS IF it is different this time, and fundamentals don't count.
Mother Nature, and real economics of supply, demand, profits, and shit like that, bat last.
The only question is what inning are we in.
If you thought Greenspan and Bernanke's busts were nice, put your face in Yellen's fat sweaty BUST.
yes
Massive Government Stimulus just moved up infrastructure projects by 10-15 years. Those jobs are now complete so do we start on stuff not needed for 20-25 more years?