Thursday, March 5, 2020

Fed Chairman Confirms Fed's Role As The Great Enabler

At Best, The Fed Is Simply A Flawed Institution
As questions swirl about the Fed's independence Fed Chair Powell has been busy trying to explain his reason for the  "emergency" 50bps rate cut. Regardless of what he says Fed Chair Powell has confirmed the Fed plans to continue its role as the great enabler. This means central banks across the globe can now lower their rates or do additional stimulus without damaging the delicate balance in the relationship in the value of one major currency to another. This is a delicate balance they have long held in check to stabilize the financial system and add credence to the myth no major currency can fail.

            Powell said,  “My colleagues and I took this action to help the U.S. economy 
            keep strong in the face of new risks to the economic outlook.”

Whether Powell succumbed to pressure from the highly critical words of the President for not acting immediately or fear the coronavirus would take a toll on the economy is not clear. As Powell tried to explain his actions, many of us who pay attention to such things cried "Bullshit." Not only is a rate cut uncalled for at this time, but because it will also do little to strengthen the economy. What it will do is continue to prop up asset prices and encourage risk-taking and malinvestment. This is a big deal and may even result in more negative interest rates across the world which could create greater problems.

In the Austrian business cycle theory, malinvestments are badly allocated business investments, due to the artificially low cost of credit and an unsustainable increase in the money supply. A strong case can be made that we already suffer from far to much leverage in our markets and this rate cut only encourages savers suffering from low-interest rates to take on more risk in search of higher yields. It has been pointed out on many occasions that low-interest rates do not extend down to low-income individuals with poor credit and many people fall into this category. Instead, over time these rates fuel inequality and punish the poor. Unfortunately, the concept that a rising tide floats all boats or trickle-down economics tends to heavily favor the rich. 

We see this in housing where few of the new apartment construction funds are generated locally and much of the building is no-longer based on real need but centered around the whims of huge real estate companies. This is part of the reason roughly 80% of new apartment construction is now for the high-end luxury market. Again the government and Wall Street money is driving this train. While retailers close and large buildings go empty across the land new buildings are being put up on speculation and bogus public-private partnerships are plowing vast sums of money into projects geared to compete with those that already exist. the fact is all across America the Fed is putting the small guy out of business.

Feds Low Rates Have Enabled This (click to enlarge)
Of course, the elephant in the room is the stock market and not the economy. When people like Trump point to the market as proof that all is well they put stocks in front of the real indicator of our economic strength which is the middle and lower class. The disconnect between the working people and the financial community is apparent in the difficulty people with small businesses have getting loans or financing a project while big business is fed billions of dollars by the banks and Wall Street. If anyone is losing confidence in the system it is these people. 

As you witness wild market swings and gyrations now taking place, it is important to realize this is part of the process necessary to break the well-ingrained habit of "buy the dip." This method of trading has worked since October 19th, 1987 when the Dow Jones Industrial Average (DJIA) dropped 22.6 percent in a single trading session. That is the day the actions by Fed Chairman Greenspan galvanized the mantras "buy the dip" and "don't fight the Fed." Greenspan did this by affirming the Federal reserve would be there "to serve as a source of liquidity to support the economic and financial system." 

The trading patterns flowing from investors buying the dip have become ingrained in the algorithms embedded deep inside the computers that drive much of the stock market's action. As noted at the beginning of this article, to the chagrin of those with a negative view of the Fed, Powell has confirmed the Fed plans to continue as the great enabler allowing central banks across the globe to lower their rates or do additional stimulus without weakening their currency compared to the dollar. I continue to contend this explains the recent weakness in the dollar and the strength in the yen as wealth continues to flow out of China.

The rapid expansion of debt and credit during the last decade could not have occurred without the Fed being complicit. When things move too far in one direction adjustments do occur. Do not be surprised if the dollar again jumps higher as the reality sets in that many countries will do far worse than America in the coming months. For now, we watch and wait while the market again tries to discover its true value both here in America and across the world.

1 comment:

  1. Bruce
    You are a man of many words and I think you picked the very best one in describing Powell's reasoning in the first part of your post. "Bullshit" It is sad to say but most of what comes out of D.C. could fall under that category.
    Thanks Chris