The Federal Reserve’s tools for achieving its dual mandate of low inflation and full employment manipulate interest rates and therefore markets. This manipulation of rates reverberates globally. Their manipulation historically had been more light handed and invisible to most of the public. However, over the last decade, their impact on interest rates and yield levels have been the most dramatic in the history of the Federal Reserve.
Whenever you have policies that are extreme, it is best to stay at extremes for the shortest time possible. Newly employed policies always have unknown and unexplored side effects that can prove to be harmful and detrimental. For instance, pharmaceutical companies have a long testing period before new products can be offered to the public. But monetary policy works with impunity towards negative consequences. No accountability and the subterfuge of finding other scape goats encourage testing these extremes.
During economic downturns, the Federal Reserve experiences pressure from politicians and the public to act in whatever manner necessary. Pressure to adequately address what are normal and healthy corrections in long business cycles is smothering and the Federal Reserve members oblige. But obliging over the past decade without reverting policy back to normal has created unprecedented low levels of interest rates and trillions in bonds on the Fed’s balance sheet, flooding the banking system with an unhealthy amount of funds.
The Federal Reserve has arguably achieved its dual mandate years ago. The employment situation has been healthy and healed for years and now is considered historically as tight as this country has ever experienced. This will lead to scarcity of labor in certain sectors going forward. Businesses will be confronted with higher labor costs competing for limited resources or relocating to areas with more abundant labor.
But what about inflation? The Fed’s preferred gauge of inflation seems to be running at or slightly below their targeted level of 2%. Sounds like they have hit their target even though they have pursued the most aggressive monetary policy in the worlds history. Shouldn’t we have runaway inflation with such easy central bank policies?
Unfortunately, we do. Inflation is, simply put, out of control. If the Fed took their inflation blinders off and included asset prices into their inflation statistics, the negative ramification of their policies would be apparent. Fed policies have led to hyper- inflation and parabolic moves higher in certain financial asset classes. Inflation in goods and services consumed can be difficult for the public. But this type of inflation does not lead to systemic issues putting the economy at risk of a severe downturn. However, the financial asset inflation Fed policy has created, but turns a blind eye to, is dangerous and destructive and can take years to remedy.
One asset class that typically shows Fed induced asset inflation is in housing. In 2006, easy Fed policy lead to rapid inflation in this asset class and contributed to the protracted downturn and systemic issues of 2008 and beyond. Current Fed policy is producing gains in housing two to three times the rate of preferred Fed calculated inflation. History sure does rhyme if not repeat.
Housing is a more visible asset class that is easy to see asset inflation - or bubble like conditions - as they happen. Another asset class that has seen significant asset inflation and bubble like conditions are crypto-currencies such as Bitcoin. Bitcoin has had meteoric appreciation of around 1,500% this year. Fed policy of taking all interest away from savers for such a protracted period has made alternate stores of value that also pay no interest a viable alternate currency. Had the Fed not changed the system of fiat currency that encourages holders by providing a level of interest that is greater than the loss of purchasing power, such alternate currencies would not be making headlines. Worse, now that they have been receiving such media attention, people are investing and using these currencies without realizing, like the tulip mania, the crypto store of value may just be a fad with nothing to show once the fad runs its course. At the end of tulip mania, fortunes were ruined, but the gardens still had pretty flowers to console. I hope a Bitcoin screensaver will console as well when its store of value disappears.
How many other crypto-currency like bubbles are percolating under the system? How much asset inflation have we experienced since the Fed unleashed the easiest monetary conditions upon us? Questions, that when answered, will leave many with losses and economic difficulties. Is it worth turning a blind eye to the asset inflation byproduct of Fed policy because it is not measured in preferred inflation metrics? Some say ignorance is bliss. Is it?
by Michael Carino, Greenwich Endeavors, 12/7/17
Michael Carino is the CEO of Greenwich Endeavors and has been a fund manager and owner for more than 20 years. He has positions that benefit from a normalized bond market and higher yields.