Stock & Bond Investors Are Now Paying The Price For The Fed's Dangerous Experiment

Authored by Vitaliy Katsenelson via,

The Federal Reserve’s changing of the guard — the end of the Janet Yellen’s tenure and the beginning of the Jerome Powell era — has me remembering what it was like to grow up in the former Soviet Union.

Back then, our local grocery store had two types of sugar: The cheap one was priced at 96 kopecks (Russian cents) a kilo and the expensive one at 104 kopecks. I vividly remember these prices because they didn’t change for a decade. The prices were not set by sugar supply and demand but were determined by a well-meaning bureaucrat (who may even have been an economist) a thousand miles away.

If all Russian housewives (and house-husbands) had decided to go on an apple pie diet and started baking pies for breakfast, lunch, and dinner, sugar demand would have increased but the prices still would have been 96 and 104 kopecks. As a result, we would have had a shortage of sugar — a common occurrence in the Soviet era.

In a capitalist economy, the invisible hand serves a very important but underappreciated role: It is a signaling mechanism that helps balance supply and demand. High demand leads to higher prices, telegraphing suppliers that they’ll make more money if they produce extra goods. Additional supply lowers prices, bringing them to a new equilibrium. This is how prices are set for millions of goods globally on a daily basis in free-market economies.

In the command-and-control economy of the Soviet Union, the prices of goods often had little to do with supply and demand but were instead typically used as a political tool. This in part is why the Soviet economy failed — to make good decisions you need good data, and if price carries no data, it is hard to make good business decisions.

When I left Soviet Russia in 1991, I thought I would never see a command-and-control economy again. I was wrong.

Over the past decade the global economy has started to resemble one, as well-meaning economists running central banks have been setting the price for the most important commodity in the world: money.

Interest rates are the price of money, and the daily decisions of billions of people and their corporations and governments should determine them. Like the price of sugar in Soviet Russia, interest rates today have little to do with supply and demand (and thus have zero signaling value).

For instance, if the Federal Reserve hadn’t bought more than $2 trillion of U.S. debt by late 2014, when U.S. government debt crossed the $17 trillion mark, interest rates might have started to go up and our budget deficit would have increased and forced politicians to cut government spending. But the opposite has happened: As our debt pile has grown, the government’s cost of borrowing has declined.

The consequences of well-meaning (but not all-knowing) economists setting the cost of money are widespread, from the inflation of asset prices to encouraging companies to spend on projects they shouldn’t.

But we really don’t know the second-, third-, and fourth derivatives of the consequences that command-control interest rates will bring. We know that most likely every market participant was forced to take on more risk in recent years, but we don’t know how much more because we don’t know the price of money.

Quantitative easing: These two seemingly harmless words have mutated the DNA of the global economy. Interest rates heavily influence currency exchange rates. Anticipation of QE by the European Union caused the price of the Swiss franc to jump 15% in one day in January 2015, and the Swiss economy has been crippled ever since.

Americans have a healthy distrust of their politicians. We expect our politicians to be corrupt. We don’t worship our leaders (only the dead ones). The U.S. Constitution is full of checks and balances to make sure that when (often not if) the opium of power goes to a politician’s head, the damage he or she can do to society is limited.

Unfortunately, we don’t share the same distrust for economists and central bankers. It’s hard to say exactly why. Maybe we are in awe of their Ph.D.s. Or maybe it’s because they sound really smart and at the same time make us feel dumber than a toaster when they use big terms like “aggregate demand.” For whatever reason, we think they possess foresight and the powers of Marvel superheroes.

Warren Buffett — the Oracle of Omaha himself — admitted that he doesn’t know how the QE experiment will end. And if you think well-meaning economists running central banks know, you may have another thing coming.

Alan Greenspan — the ex-pope of the Federal Reserve — in a 2013 interview with the Wall Street Journal said that he “always considered [himself] more of a mathematician than a psychologist.” But after the 2008-09 financial crisis and the criticism he received for contributing to the housing bubble, Greenspan went back and studied herd behavior, with some surprising results. “I was actually flabbergasted,” he admitted. “It upended my view of how the world works.”

Just as the well-meaning economists of the Soviet Union didn’t know the correct price of sugar, nor do the good-intentioned economists of our global central banks know where interest rates should be. Even more important, they can’t predict the consequences of their actions.

*  *  *
Vitaliy Katsenelson is the CIO at Investment Management Associates, which is anything but your average investment firm. (Seriously, take a look.) He wrote two books on investing, which were published by John Wiley & Sons and have been translated into eight languages. 


Yen Cross Sun, 02/11/2018 - 22:07 Permalink

  Not the ones old or smart enough, to see through all the bullshit.

  Snowflakes be warned, the day of tempest is upon you.

  * sell the rips~

  Did someone get their feelings hurt?   wahhh- wahhh.

MusicIsYou Sun, 02/11/2018 - 22:12 Permalink

Oh yeah man, and one of the biggest indicators of the U.S going into a death spiral like the former Soviet Union is the increasing push for an Iron Curtain on the U.S/Mexico border. And U.S infrastructure is falling apart like the USSR too. America is never going to be great again and the sooner you accept it the happier you'll be. It never really behooves people to run away from their country. And see now, all those people fled the USSR and eastern Europe just to come to the U.S to go through it all again. That's like all the people who left Europe to come to America 150 years ago, but those families are no more free than had they just stayed in Europe in the first place.

. . . _ _ _ . . . Sun, 02/11/2018 - 22:13 Permalink

Even more important, they can’t predict the consequences of their actions.

The only valuable comment in this article.
Chaotic systems (complexity science) are impossible to predict... impossible.
This Newtonian view of the 'science' of economics went out the window with Chaos theory.
Just ask Fischer Black and Myron Scholes .

Hongcha Sun, 02/11/2018 - 22:29 Permalink

Breathless gloom over a natural 10% correction after a nearing-asymptotic spike.  Shorts will get their faces handed to them after we make newer-er highs by the end of the month.

MusicIsYou Sun, 02/11/2018 - 22:33 Permalink

It never behooves people and families to run away from their country, not in the grand scheme of things it doesn't. All the countries around the globe wish they had more people in their own population like me. Because the root of world wide problems is envy and thinking the grass is greener on the other side.

daveO Sun, 02/11/2018 - 22:36 Permalink

At least the author called Greenspan the former "pope" of the FED. I said for years that most economists are our high priests of financial fraud.
There are no well meaning bureaucrats or economists. They are, nearly all, self serving government employees.

MusicIsYou daveO Sun, 02/11/2018 - 22:47 Permalink

Well they aren't going to really help you get rich because then you'll be horning in on their turf. And besides that, they need you to want to be them to justify their wealth in their own minds. Much like the same way a minister needs a congregation to justify the minister's beliefs. A church minister is unto a Facebook meme, the more people he gets into his congregation is the same thing as clicking his "Like" button. Like "It must be true because a 1000 other people believe it too."

In reply to by daveO

Md4 Sun, 02/11/2018 - 23:05 Permalink

If we're ever going to get better, we first have to get real honest about causes, AND effects. While we may not be fully able to predict the latter, we can certainly endeavor to find the former.

Some of you may be familiar with LEAN concepts in your professional lives. They are problem solving principles used to honestly evaluate cause-and-effect. Honesty is, of course, key.

One of these methodologies are called "The Five Why's". No one is limited to only five steps back through the problem to discover the holy grail of all problem solving: the "Root Cause". If actually looking for the truth in a given situation, you ask "why" as much as is necessary.


It works!


So...I'd ask the author (and many like him), given his statement specifically about QE, and subsequent actions being ever NECESSARY in the first place:

"nor do the good-intentioned economists of our global central banks know where interest rates should be. Even more important, they can’t predict the consequences of their actions."


Why? Sun, 02/11/2018 - 23:50 Permalink

There are several issues: 

1. Quantitative Easing -- Japan has been printing money over 15 years and it has done very little.  Growth has been very limited.  It distorts the signal from interest rates.

2.  Low rates over a long period--9 years  This is a real problem for pension funds and conservative investors as they fall behind inflation and build up long term problems.

3.  Moving people out the risk curve--This is the big one as you have pushed fixed income investors into high yielding stocks and increased the allocation to equities for others.  Every one is in and a lot of people do not want to be there and will exit at some point.  It multiplies the risk in a correction as few buyers are on the sidelines.  Few shorts remain and so support from them in a decline will be minimal.  Where will the buyers come from as the weak longs leave?  

Md4 Mon, 02/12/2018 - 00:55 Permalink

Good points.

But all are effects of something else.

For example, Japan was an exporter for most of it's GDP.

It began to place enormous cost and quality pressure on domestic American manufacturing in the 1980's.

How did we respond?

By ultimately outsourcing domestic manufacturing to cheaper labor sources, like China and Mexico.

It is only in the early trickle stages of outsourcing, that all SEEMS like a win-win situation.

The sourcing country hasn't begun to feel the long-term effects (what you are describing, and more) yet.

Meanwhile, the receiver countries are jubilant at the sudden "new" prosperity.

As we all now see, jobs lost in sourcing nations erode the capacity to consume, without a lot of ultimately-futile financial engineering (credit and debt created--not earned) to mimic what it lost (gave away).

Sooner or later, BOTH sides begin to collapse.

There wasn't any foresight to parallel a new and prosperous economy alongside the old one leaving.

Now, the source can't spend, and the receiver struggles to survive without that expected spending.


All the shenanigans (again, coping efforts you describe) since the full effects kicked in, have made matters much less honest, and a helluva lot more precarious.

Except for a handful of people benefiting, they haven't fixed a goddamned thing.

The experts are confounded because they don't want to accept and own the damage they, and their predecessors, caused.

THAT'S the bottom line.

In reply to by

verumcuibono Md4 Mon, 02/12/2018 - 13:15 Permalink

Federal Reserve is fraudulently based on foreign corporations: we need to audit and seize assets of Federal Reserve AND its 12 Central Banks and default on the debt. Our contract w/ FR was renewed last year but we can breech it at any time - we do not owe this debt! This does not require any action of Congress. We can make $20T in a day.

I've been somewhat MIA for the past few days so I don't know if you guys have already talked about this but someone needs to ask the INSOLVENT Central Banks what they learned on Jan 3 that PLUNGED INTERbank lending that ceased lending between the banks ENTIRELY. What better indicator of insolvency is there than historic, multi-decade precipitous drop in confidence in lending to each other? This started in 2008 - then we saw the drop in the Dow in Dec 2017.

With recent market movements we expect flight-to-safety flow into Ts or G/S or Bitcoin but $4T IN MARKET VALUE MISSING. Physical gold?

In reply to by Md4 Md4 Mon, 02/12/2018 - 20:53 Permalink

The big mistake has been that we celebrated the fact that first Japan and then China were buying our bonds.  They were actually managing their currencies and we allowed them to keep their currencies lower than they should have been.  This is why we lost so many manufacturing jobs.  Moving manufacturing to lower cost areas is OK if they are playing fair as we tend to do a pretty good job of adjusting and finding other areas to compete but what happened with China in particular and to a lesser extent Japan is the huge mistake over many years.  My above comments about money printing/QE are different.  It is the central banks deciding they should be managing the economy instead of responding to industrial development.  We are now a centrally planned economy and that is not the best model.

In reply to by Md4

GETrDun Sun, 02/11/2018 - 23:53 Permalink

When Greenspan went in front of Congress and used double speak to answer questions. He was giving them the finger from the real masters if the universe.

nuerocaster Mon, 02/12/2018 - 00:53 Permalink

The Net Tax Receivers Club, The Monopoly Club, The Crime Syndicate Imperialism Club, were firmly in control prior to the Leverage Club ramp job.

Speaking of said ramp, derivatives and deregulation were greater turning points than CBs intervention.

Check out the tax rates and loopholes in the 50s, Great Society 60s, WWII 40s, New Deal 30s.

The peculiar monopoly blindness in the US.

The denial of the nature of the activities of the military, intelligence, and darker complexioned Capos er I mean clients er uh allies.

This article is pure ignorance or a con job.

BTW interest rates are an indicator of the capital value of money. Only an indicator. Capital value is local.

Sonny Brakes Mon, 02/12/2018 - 01:05 Permalink

If we actually lived in a market economy there's no way that a banker would be agreeable to federal counterfeiting, but since the banker's job is simply to create fiat currency out of thin air and collect their fees and interest payments, they've decided that they're willing to play along. The money men have their wealth in gold and silver and any other rare and precious metals. Sure they roll in cash, but when cash goes to zero they'll still have their gold and they'll foreclose on those who are unable to meet their obligations. They don't care about their bank, their community, or their country. The same bank that holds your mortgage is also ready to finance your employer when he decides to replace your job with a robot.

farmboy Mon, 02/12/2018 - 01:28 Permalink

Setting rates is just one part of the new USSA. Media control, double speak, market interventions, it all serves to support a crumbling empire. 

AvoidingTaxation Mon, 02/12/2018 - 03:29 Permalink

""Anticipation of QE by the European Union caused the price of the Swiss franc to jump 15% in one day in January 2015, and the Swiss economy has been crippled ever since.""
What? Swiss economy is now 19th worldwide with population going up 1% a year as foreigners continue to come in to work (or not). 32% foreigners now, and Switzerland has spare billions to give as tokens to the failed EU i order not to be bothered by the crap coming from Bruxelles.
A slowly appreciating CHF is paramount for Switzerland well being. Swiss people dont like to devalue and be devalued. Swiss people like to appreciate and be appreciated.

Plus the SNB accumulated 750B while printing, did not waste them bombing rocks in Afghanistan to find a dude that was in Pakistan and dropped in the Indian ocean like a rock.