Why The Fed Will Fail Once Again

Tyler Durden's picture

Authored by James Rickards via The Daily Reckoning,

John Maynard Keynes once wrote, “Practical men who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist.”

Truer words were never spoken, although if you updated Keynes today, the quote would begin with “practical women” to take account of Fed Chair Janet Yellen. The “defunct economist” in question would be William Phillips, inventor of the Phillips curve, who died in 1975.

In its simplest form, the Phillips curve is a single-equation model that describes an inverse relationship between inflation and unemployment. As unemployment declines, inflation goes up, and vice versa. The equation was put forward in an academic paper in 1958 and was considered a useful guide to policy in the 1960s and early 1970s.

By the mid-1970s the Phillips curve broke down. The U.S. had high unemployment and high inflation at the same time, something called “stagflation.” Milton Friedman advanced the idea that the Phillips curve could only be valid in the short run because inflation in the long run is always determined by money supply.

Economists began to tweak the original equation to add factors — some of which were not empirical at all but model-based. It became a mess of models based on models, none of which bore any particular relationship to reality. By the early 1980s, the Phillips curve was no longer taken seriously even by academics and seemed buried once and for all. RIP.

But like a zombie from The Walking Dead, the Phillips curve is baaaack!

And the person who has done the most to revive it is none other than Janet Yellen, the 70-year-old liberal labor economist who also happens to be chair of the Federal Reserve.

Unemployment in the U.S. today is 4.3%, the lowest rate since the early 2000s. Yellen assumes this must result in inflation as scarce labor demands a pay raise and the economy pushes up against the limits of real growth. Yellen also agrees with Friedman that monetary policy works with a lag.

If you believe that inflation is coming soon and that policy works with a lag, you better raise interest rates now to keep the inflation from getting out of control. That’s exactly what Yellen and her colleagues have been doing.

Meanwhile, back in the real world, all signs point not to inflation but to deflation. Oil prices are declining, intermediate-term interest rates are falling, labor force participation is falling, demographics favor saving over spending and logistics and supply-chain giants like Wal-Mart and Amazon are relentlessly squashing price increases wherever they appear.

Even traditional high-price sectors like college tuition and health care have been cooling off lately.

Yellen and a small group of Fed insiders, including Bill Dudley and Stan Fischer, are keeping up the drumbeat for more rate hikes later this year. Opposition to more rate hikes among Fed officials is growing, including from Neel Kashkari, Lael Brainard and Charles Evans.

This intellectual tug of war is coming to a head.

First, bonds are rallying because the bond market expects a recession or slowdown due to unnecessary tightening by the Fed. Which brings me to Bill Gross…

Practically every investor has heard of Bill Gross. For decades he was the head of PIMCO and ran the world’s largest bond fund. His specialty was U.S. Treasury debt..

PIMCO was always a “bigfoot” in the bond marketplace. In the 1980s and 1990s, I was chief credit officer at a major U.S. Treasury bond dealer, one of the so-called “primary dealers” who get to trade directly with the Federal Reserve open market operations trading desk.

PIMCO had dedicated lines and a dedicated sales team at our firm. When they called to buy or sell, it would move markets. Every primary dealer wanted to be the first firm to get the call.

Gross is famous for outperforming major bond indices by a wide margin. The way to do that is market timing. If you sell bonds just ahead of a rising rate environment, and buy them back when the Fed is ready to reverse course you not only capture most of the coupon and par value at maturity, you can book huge capital gains besides.

Now Gross has issued one of his most stark warnings yet. He says that market risk levels today are higher than any time since just before the 2008 panic. We all know what happened then. Gross says it could happen again, and soon.

No one reads the market better than Bill Gross. So, when he issues a warning, investors are wise to pay attention.

The stock market is giving a different signal. Stocks are rallying because markets interpret Fed rate hikes as a signal that the economy is getting stronger.


Both markets cannot be right. Either stocks or bonds will crash in the weeks ahead.

Gold is watching and waiting, moving down on deflation fears and then up again on the view that the Fed will have to reverse course once the economy cools down.

My models show that bonds, Bill Gross and gold have it right and that stocks are heading for a fall.

The stock market correction won’t come right away, because the Fed is still in a mode to talk up rate hikes and strong growth and to dismiss disinflation as “transitory.”

Yet even Janet Yellen can’t ignore reality forever. The Atlanta Fed GDP growth forecast for the second quarter has gone from 4.3% on May 1, to 3.4% on June 2, to 2.9% on June 15.

Today it released its latest growth forecast, which remains unchanged from its June 15 reading — 2.9%.

Something is slowing down the economy, and that something is Fed rate hikes.

By August, even the Fed will get the message. But by then it may be too late. If Q2 growth comes in at 2.5% combined with Q1 growth of 1.2%, that would put 2017 first-half growth at about 1.85%.

That’s even weaker than the historically weak 2.0% growth of the current expansion since June 2009. This is not the stuff of which inflation is made.

The Fed’s bungling should come as no surprise.

The Federal Reserve has done almost nothing right for at least the past twenty years, if not longer. The Fed organized a bailout of Long-Term Capital Management in 1998, which arguably should have been allowed to fail (with a Lehman failure right behind) as a cautionary tale for Wall Street.

Instead the bubbles got bigger, leading to a more catastrophic collapse in 2008. Greenspan kept rates too low for too long from 2002-2006, which led to the housing bubble and collapse.

Bernanke conducted an “experiment” (his word) in quantitative easing from 2008-2013, which did not produce expected growth, but did produce new asset bubbles in stocks and emerging markets debt.

Yellen is now raising rates in a weak economy, which should produce the same recessionary reaction as 1937, the last time the Fed raised into weakness.

Why this trail of blunders?

The answer is that the Fed is using obsolete and defective models such as the Phillips Curve and the so-called “wealth effect” to guide policy. None of this is new; I’ve been saying it for years in books, interviews and speeches.

What is new is that even the mainstream media is beginning to see things the same way. Fed leaders have been exposed as charlatans, like the Professor in the Wizard of Oz.

The Fed’s latest failure will cause policy to shift to ease before September in the form of forward guidance on no further rate hikes this year. Just one more failure in a long list.

It’s time to load up on Treasury notes, gold and cash and lighten up on stocks. The Fed may be the last to learn about deflation, but when they do, the policy response could be instantaneous and markets could suffer whiplash.

That’s what happens when zombies are on the loose.

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Jim in MN's picture

Just normalize interest rates and stop torturing us with your banal non-statements.

Go Home.

Blue Balls's picture

End the Fed.  Hang the bankers.  Return to sanity and a normal society.

Stackers's picture

The Phillips curve does still work. You just have to stop lying about how you count unemployment.

Start counting unemployment correctly again, and you're at 10-15+++% unemployment and suddenly things start making sense....

Blue Balls's picture

The only objective was making profits.  The rest is BS.  Ripping off the peasants was just part of the process.

marathonman's picture

And why does everyone in media say that inflation is non-existant?  In 2010 I could go get a burger meal for less than $5.  Now that meal is $10.  Prices doubling in seven years?  That's a 10% inflation rate.  All the low inflation talk is BS.

chunga's picture

Because the whole thing is one giant fraud. It's all fraud, every drop of it.

The only way to kill zombies is shoot them right in the head.

knukles's picture

The last thing the Fed did "right" was Volcker's Saturday Night Massacre, moving from targeting interest rates (Neo-Keynesian) to targeting the quantity of money available in a high demand environment.

HardAssets's picture

All the banksters are thieves including Volcker. He just happened to believe they could better extend their parasitic run by taking the actions he did.

We need these banksters about as much as we need a tape worm.

Creative_Destruct's picture

"Fed leaders have been exposed as charlatans, like the Professor in the Wizard of Oz."

The curtain's been pulled back for MUCH longer than 20 years... 

"There are none so blind as those that refuse to see"

GoldRulesPaperDrools's picture
It's not even in the last TEN years, it's in the last TWO years.  Any business that's in the position to raise prices to make up for lack of demand has/is doing so.  The ones who can't are dying (some slowly, some not so slowly).
Singelguy's picture

Actually, real inflation has been running about 8% since 2008. The "hedonic" and other "adjustments" have brought the official rate below 2%

Creative_Destruct's picture

Oh, but that burger meal has been hedonically indexed.... you're apparently getting a  MUCH "better quality" hunk of cow in that (much smaller) patty.

are we there yet's picture

I have been working for free for the last 9 years to keep my company running and my employees employed. I love what I do, but pay wise I have been unemployed for 9 years.

GoldRulesPaperDrools's picture

I'd be willing to do that too, but I'd have to have a couple of attractive employees who could suck a brick through a garden hose ... ;)

HardAssets's picture

Normalize interest rates ?

They charge interest on 'credit' they make up outta thin air.

How bout they do a long prison term instead ? (And their partners-in-crime in government.)

Rich Monk's picture

You must be kidding right? The Fed has done a brilliant job of creating profits for the central bank owners with bubbles ever since it was created in 1913 even though it has destroyed America!

Blue Balls's picture

Yes but income inequality progress really took off when Nixon ended Bretton Woods.  After that it was nothing but touchdown Fed.

GRDguy's picture

Yep, highly successful in lyin' and stealin' from most everyone else.

Shitonya Serfs's picture

Agreed. The Fed is performing perfectly. Issuing/printing debt for the US and almost every other country in the world. Yet almost everyone "fails" to see this.

If I had the ability to print "money" and hand it out in trade for real goods, plus interest (requiring me printing you more money to pay that, plus more interest), I would do that infinitely.

GunnerySgtHartman's picture

The only thing the Fed has done right in the last 103 years is Volcker breaking the back of inflation (as painful as that was for the economy at large).

Fisherman Blue's picture

I hate .Gov and the central banks who feed that beast. They hate me too. Obviously they hate all non tribe members. 

Unreliable Narrator's picture

Stupid article.  How the hell are the Fed rate hikes "slowing" the economy?  It's the easy money from low rates that killed the economy.  When it becomes more lucrative to take out huge loans for stawk buybacks than to invest in capital assets or people, then loans will be taken and stawks will be bawt.

Raising rates must be done.  The asset bubble must be popped.  The Fed's problem is that they waited too long to do it.

Singelguy's picture

It is very simple. Since the Fed cut rates to almost zero, global debt has grown by $28 trillion. That is a lot of debt! Higher rates mean higher debt service costs which takes away from research and developmen on the business side, and disposable income on the consumer side. The stawk buybacks are coming to an end. Corporations have piled up too much debt. Rate hikes will put that final nail in the coffin and if rates go up enough, it will bankrupt some pretty big companies. IBM is the poster child with $35 billion in debt piled up to buy back their stock.

Batman11's picture

Neoclassical economics is the global elite’s grand creation.

The early Classical Economists soon started to cause problems for those at the top by noting the mechanisms by which they were maintained in luxury and leisure and how they were essentially parasites on the economic system.

In the 18th and 19th centuries they were aware there were two sides to capitalism, the productive side where “earned” income is generated and the unproductive, parasitic, rentier side where “unearned” income is generated.

They knew the unproductive side worked against the productive side and believed all taxes should fall on “unearned” income.  

Neoclassical economics corrupted Classical Economics at the end of the 19th and beginning of the 20th Century. 

The distinction between “earned” and “unearned” income disappears at this point and the once separate areas of “capital” and “land” are conflated.

The landowners, landlords and usurers are now just productive members of society and not parasites riding on the back of other people’s hard work, but they are.

BUT ......

This leads to parasitical rentier economies, now spotted by one of today’s Nobel Prize winning economists  “Income inequality is not killing capitalism in the United States, but rent-seekers like the banking and the health-care sectors just might” Angus Deaton.

A floored model of global, free trade that doesn’t consider the minimum wage is set by the cost of living. Western labour is priced out of global labour markets by the high cost of living in the West exacerbated by rentier behaviour.

Known and lost one hundred years ago (deliberately as those at the top are parasites)

In the UK we have our aristocracy that have been idle for centuries to remind us.

When it was obvious:

Adam Smith:

“The labour and time of the poor is in civilised countries sacrificed to the maintaining of the rich in ease and luxury. The Landlord is maintained in idleness and luxury by the labour of his tenants. The moneyed man is supported by his extractions from the industrious merchant and the needy who are obliged to support him in ease by a return for the use of his money. But every savage has the full fruits of his own labours; there are no landlords, no usurers and no tax gatherers.”

They have been busy hiding how private banks create money.

The understanding of money and debt have been regressing for one hundred years.

Credit creation theory -> fractional reserve theory -> financial intermediation theory

 “The movement from the accurate credit creation theory to the misleading, inconsistent and incorrect fractional reserve theory to today’s dominant, yet wholly implausible and blatantly wrong financial intermediation theory indicates that economists and finance researchers have not progressed, but instead regressed throughout the past century. That was already Schumpeter’s (1954) assessment, and things have since further moved away from the credit creation theory.”

“A lost century in economics: Three theories of banking and the conclusive evidence” Richard A. Werner


You need the “credit creation theory” of money to get a grip of financial crises and financial instability and today we don’t have that in the mainstream leading to boom/bust capitalism.



Batman11's picture

Financial stability has been a mystery in this era of boom/bust capitalism.

2008 – “How did that happen?”

The early 1980s see the beginnings of financial liberalisation and the late 1980s sees the following crises, e.g. US S&L crisis; UK, Japan, Australia, Canada and Scandinavia real estate busts.

More financial deregulation leads to 2008; the Euro-zone crisis; Irish, Greek and Spanish real estate crashes.

2008 is just another real estate bust, leveraged up and transmitted internationally by complex financial instruments. As the global bust hits the Euro-zone, it crumbles.

Australia, Canada and Scandinavia are queuing up for their second real estate bust.

Today’s neoclassical economics was around in the 1920s and it led to the roaring 20s and the Great Depression. The roaring 20s, roared because of debt based consumption and debt based speculation. All the debt built up in the boom led to the debt deflation of the Great Depression.

Neoclassical economics was revamped but it still has its old problems.


1929 and 2008 stick out like sore thumbs when you look in the right place.

The build up in the ratio of debt to GDP signals the build up of unproductive lending into the economy leading to a Minsky Moment (1929 and 2008).

Productive lending goes into business and industry.

Unproductive lending goes into real estate and financial speculation and it shows up in the graph above.

The UK:


We have a problem, a real estate fuelled economy driven by unproductive lending that naturally leads to financial instability.

Neoclassical economics doesn’t consider private debt in the economy and naturally leads to boom/bust capitalism because of this over-sight. It doesn’t even consider debt and so can’t make the finer distinction between productive and unproductive lending.

If you want financial stability, don’t use neoclassical economics.

Batman11's picture

Let's follow the diktats of neoclassical economics.

It's a load of bollocks that looks after the elite.



Batman11's picture

Getting bullshit economics accepted - a fake Nobel prize.

The economics prize is a bit different. It was created by Sweden’s Central Bank in 1969, nearly 75 years later. The award’s real name is the “Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel.” It was not established by Nobel, but supposedly in memory of Nobel.”   

The “Nobel” prizes helped to give the refurbished neoclassical economics credibility and allow it to push out the old Keynesian ideas (goodbye equality).


In 1997, Robert Merton and Myron Scholes, won the “Nobel” prize for their derivative risk models that minimised risk.

They formed a company Long Term Capital Management using these ideas that blew up a year later posing a systemic risk to the global financial system.

The pseudo “Nobel” economics prize isn’t up too much.

Greenspazm's picture

"My models show that bonds, Bill Gross and gold have it right and that stocks are heading for a fall"

Dear Mr Ricktards: "your models" in this ghost-written piece from Agora's pump-and dump shop don't show dick.

michigan independant's picture

Unemployment in the U.S. today is not 4.3%. Despite collecting record amounts of individual income taxes and payroll taxes, the Treasury still ran a deficit of $526,855,000,000 in the first six months of fiscal 2017.

GunnerySgtHartman's picture

Despite collecting record amounts of individual income taxes and payroll taxes, the Treasury still ran a deficit of $526,855,000,000 in the first six months of fiscal 2017.

Pretty damn scary.

Schlub's picture

Make the bubble, burst the bubble, fleece the wealth... Am I missing anything?

gregga777's picture

The Goldman Sachs Feral Reserve System always Succeeds!

• They caused the credit boom and crackup that led to the Great Depression (1929-1945).

• They caused the credit boom and crackup that led to the Greater Depression (2007-and counting).

• They caused the credit boom and are causing the crackup that will lead to the Greatest Depression (TBD-unknown).

The Goldman Sachs Feral Reserve System has a perfect record. They deliberately cause the credit booms and crackups. It's all part of their owners plan to impoverish the American People and America.

Voice of insanity's picture

Why waste time finding new ways to fail, when the old ways work just as well?

pound the vix's picture

The real measure of if the Fed is correct is if Goldman/Merrill/JPMorgan are given the direction the Fed is moving in advance, they are able to put on their trades and the fed does what it told them it was going to do.  The Fed cannot change direction because these investments take time to unwind (i.e 30 year mortgages need to be bundled and sold.  Leverage loans need to be converted into equity, etc.  As long as JP morgan does not have a single day when they loss money on their trading floor you can tell the collussion is in full effect and "The Fed is Correct"

gregga777's picture

The last time I looked at Shadowstats.com unemployment was 23%. The Goldman Sachs Feral Reserve System LIES about everything except when they assert in Federal courts that they are NOT a part of the United States of America's Feral Gangster Government in any way, shape or form. But, then what do you expect from a bunch of evil "you know who's"?

SubjectivObject's picture

The Fed is highly successful and is not bungling anything.

Any perception of bungling is muddia red herring cooked for consumption by the peon proles.

gregga777's picture

Dear American People,

When your pension plans admit that they are insolvent and they slash your pensions over the next decade, just remember one thing:

It's all the fault of the evil Goldman Sachs Feral Reserve System.

vegas's picture

Dear Jim: Maybe you didn't get the memo, but the meme here with the FED is "transitory". See, now don't you feel better?



OKUSA's picture

Everyone has lied so much about the economy, that they can't remember what the truth is anymore. Do we cut the red, green, or blue wire? No one knows.

zzzz88's picture

LONDON (Reuters) - U.S. Federal Reserve Chair Janet Yellen said on Tuesday that she does not believe that there will be another financial crisis for at least as long as she lives, thanks largely to reforms of the banking system since the 2007-09 crash.

Kendle C's picture

Stopped reading at: "Unemployment in the U.S. today is 4.3%, the lowest rate since the early 2000s." This is some kind of psy-op insertion tactic. Someone postulated that if a person hears something 36 times they take it to be true AND they consistently forget the source. Thanks fucker.

Alananda's picture


Problem -- Print "money" from nothing, practice usury by whatever name, make off like a bandit!

Solution -- END THE FED with a debt jubilee, reset nonviolently.

AnarchistRex's picture

The FED does not 'bungle'; the FED does not 'fail' .... they act deliberately - even when, to the common ignorant person, they appear to bungle ... they make huge insider profits for their crony friends which is a success for them and not a failure ... again ignorance is bliss ... keep bending over for your masters by using their fake money and you will continue to be their slaves until the day you die ... and then your children will be their slaves.

Stop using their money. Use a gold or crypto backed visa card to make your purchases and you are effectively out of their slave system.