Authored by Doug Kass
Do we want to be Japan?
"I need the Fed to shut up. I don't trust the Fed at all. I don't trust Jay Powell at all. Jay said everything that caused a tremendous selloff. You have got to start recognizing how powerful his words are."
-- Jim "El Capitan" Cramer, CNBC, on Thursday
I am in respectful disagreement with the condemnation of Fed policy by Jim Cramer and others.
To begin with, before criticizing the Jerome Powell-led Federal Reserve, market participants would be wise to look at where the stock market has come from and how equities are still valued.
The hue and cry about the recent market downdraft and the Fed are particularly revealing in light of the fact that even after the most recent downturn the market is up 13% since 2017, 23% since 2016, 34% since 2014, and 111% since 2010.
Powell only recently has brought rates to a neutral level (in real terms, adjusted for inflation), causing investors to freak out. That says a lot about both market participants and the underlying fragility of the domestic and global economies, as they, too, have become addicted to low rates. (Europe is nearing recession even though interest rates are near zero.)
Powell should continue doing the right thing, but slowly and carefully. A garden-variety recession is fine. A move down in equities is fine. Those things are normal and part of a functioning capitalistic economy. It is amazing and unhealthy that market participants seem to forget this cleansing role.
The challenge to the Fed chairman is how exactly to do the right thing, to thread the needle. This is not his fault. But any patient addicted to drugs must be weaned off of them slowly and methodically. Cold turkey will just kill the patient.
In this case the patient won't die -- a recession is normal and far from death -- but the big risk is someone comes in after Powell and reverses it all by putting the market on a massive dose of stimulus of all sorts, which will have the wealth-robbing consequences (such as inflation and default) that those who are a little more thoughtful and long-term oriented have feared all along. Powell therefore needs to tread carefully and methodically.
The president's jawboning is also far from helpful in this regard. This is partly his fault as well. Unleashing huge amounts of stimulus via his tax policy at the point in the cycle where it was done, with the government deficit where it was, is incredibly stupid and naïve. In addition to bloating the deficit, his tax policy simply turned into more inflated equity prices as the benefit of the tax cuts went to earnings and stock buybacks as opposed to back into the real economy in terms of hiring and capital expenditures.
Here are some observations on the pickle the Federal Reserve has gotten itself into. This is not Powell's fault. It is the fault of his predecessors at the Fed, and in the government. It started with Alan Greenspan and the Greenspan put, and continued with Ben Bernanke and Janet Yellen, who did not rein in stimulus fast enough. At the same time, the fiscal and policy side of things has left a lot to be desired as it has "trickled up" and not down.
The only thing for which Powell is to blame is taking the job in the first place. Armed with a law degree from Georgetown, Powell was a businessman and investment banker. In 2012 he joined the Federal Reserve's Board of Governors and became a central banker. Given that background -- and just as a judge wants to be on the Supreme Court -- a central banker wants to preside over the Fed's leadership. But in reality, it may be a no-win situation for Powell, unless you want to be another person kicking the can down the road, setting things up for a bigger disaster at some point.
The Fed has never embarked on an easing cycle from levels as low as they are today. The prior worst may have been about 3.5% in the 1950s -- still post-World War II and trying to get out of the aftereffects of the Depression. In the last cycle, the fed funds rate was already up to 5.25% before easing began. Now we can't even get back to half that level?
Over time, the U.S. economy has become horribly addicted to lower rates. There is really no place left to go now. It is a function of policy mistakes, both monetary and fiscal over a protracted period of time.
Recessions are a normal part of a business cycle in a capitalistic economy. Fighting them too much and too hard all the time might lessen volatility, but it also lessens mid- to longer- term economic growth potential.
The proof is in the pudding. This has been about the worst expansion on record. After massive stimulus we get about one quarter of 4% GDP growth, and then a decent chance of rolling right back over with rates at all of 2.5% and not much in the way of monetary or fiscal dry powder.
Contrary to the view of many, this is not Fed Chairman Powell's fault. There is about 30 years of blame to lay at the feet of a lot of people, both sides of the aisle, and at the Fed as well.
Relying upon more Fed easing, as I mentioned in a recent Fox Business interview, is the acme of fragility and vulnerability. Cleansing may deliver short-term pain, but it provides long term gain.
We do not want to be like Japan!
Here is a Bloomberg chart of the last half-century of federal funds rates; it underscores the point made in this morning's opening missive: