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Much ink has already been spilled on the so-called September “taper” which was almost pre-announced by the Federal Reserve. However, in the grand scheme of things no one will care if we spill marginally more.
In May and later in June, Chairman Bernanke went lengths to warn markets that something was brewing. For example, on May 22, Chairman Bernanke said that the Fed “in the next few meetings… … could take a step down in… … pace of purchases”. He substantiated his viewpoint at the FOMC press conference on June 19th saying
“…the Committee anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next, ending purchases around midyear”
In other words, the market consensus was conditioned to expect an imminent reduction in the large scale asset purchase program. Interest rates soared with the 10 year Treasury yield gaining 137 basis points over a three month period. In relative terms, that is the biggest move ever recorded!
What was the Fed`s view on rising interest rates in June? Asked about rates, Chairman Bernanke said it was partly due to “more optimism” and partly due to “perceptions of the Federal Reserve.” In other words, “that`s a good thing. That`s not a bad thing.”
However, as rates continued to creep upwards the Fed and its Chairman realized there were actually consequences to their folly. By suppressing rates and expanding the money supply, unsustainable demand patterns were created; or more correctly, unsustainable demand patterns prior to 2008 were resurrected and upheld. As proof of this we note that employment growth is exclusively to be found in what we call “bubble jobs”; that is jobs that cannot be sustained without the constant influx of new money. Mr. Stockman elaborates more on this concept in his latest book. In brief we can say that the “bubble job” component that were created in the Greenspan bubble perfectly match what the market liquidated in 2008 and 2009. However, the Bernanke bubble managed to re-employ every single one of them, but at lower pay and on a part time contract.
When the “stimulus” is withdrawn, these jobs cannot fund themselves and they come under stress.
In more technical terms, monetary policy does not create wealth, it only redistribute existing wealth. This process will divert real resources from wealth creators to wealth consumers and hence reduce the pool of real savings available to the loanable funds market.
While the Federal Reserve policies may give the illusion of spurring economic growth, it actually does the exact opposite. It maintains capital consuming activities through diversion of real funding.
Source: Bureau of Labor Statistics (BLS), own calculations. Kudos to Mr. Stockman!
Examples of wealth consuming activities can be drawn directly from Ben Bernanke himself. A stated goal of the quantitative easing programs is to inflate asset values in order to boost the so-called wealth effect. If people feel wealthier as a consequence of a higher nominal value of their home, they will be more inclined to go to a restaurant. The restaurant will hire more staff and economic reports come out more favorable.
Please observe that this is process not sustainable. Feeling richer does not make one richer. There is absolutely no increase in capital or productivity as a consequence of a higher valuation of one’s house. On the contrary, by going to the restaurant there is actually less capital available for income generating investments.
Suppressing interest rates and print money to boost asset prices can to some extent bring forth future consumption, but the problem obviously arises when the future comes and additional “stimulus” is needed to repeat the process ad infinitum.
When Chairman Bernanke hinted he would taper the existing program markets responded by bidding up interest rates and wealth consuming activities came under pressure.
The August labour market report was far worse than the headline numbers suggested. Housing data took a nosedive. Emerging markets could no longer fund their growing current account deficits.
Inevitable consequences were felt. What was a claimed to be a positive development in June was deemed quite differently by September as bubble activities were about to be restructured.
To everybody`s surprise Bernanke stated that higher interest rates was now something to be dreaded. The taper we all thought would come, including the FOMC itself just weeks ago, did not materialize. The FOMC decided on September 18th to maintain the current pace of asset purchases.
If there should be any doubt about what the market thought about Bernanke`s strategy, the immediate response to the non-taper news prove the extreme level of miscommunication prior to the September FOMC meeting.
Since the Federal Reserve seldom surprises markets like this, at least not in a period when they have had over three months to prepare investors, we suggest Fed officials got cold feet’s and changed their mind very late in the summer.
Source: Bloomberg, own calculations
There is only one thing central banks have that prevent their project of fiat currency and fiduciary media creation from come crashing down and that is credibility! If, for some reason, the public should lose confidence in the money provided by their government there is not enough coercion in the world to maintain the purchasing power of the currency issued. Gresham`s law is unyielding if a dogged public have understood the real value of their money.
And the FOMC lost a great deal of its credibility this summer. They single-handedly triggered the emerging market crisis and we don’t see financial flows reversing course just because the Fed opted for continuation of their QE-policy. Emerging market`s current account deficits was unsustainable and everybody know that now. Taper-off will therefore benefit the Euro and Yen, which will soon counter, all in a fallacious drive for exports. Or what we call a pathological urge to give away your products!
Secondly, and far more important, is the blatant loss of credibility when it comes to exit strategies. While any person with half a brain understood the complexities involved and sheer danger of deliberate asset inflation, it is now clear to even the people with a quarter of a brain that the Fed cannot exit its flow without causing major disruptions.
This begs the question of whether they want to exit soon and face the pain of restructuring head-on, or continue the policy until all credibility is lost and the dollar loses its status as global reserve currency.
If the Fed choose to exit today market forces would be overwhelming. Wealth consuming activities with an implicit Fed subsidy will be liquidated. This means around 50 per cent of every activity the Federal government is involved with. Further, a large amount of US consumption would disappear; triggering ripple effects to the Far East and Europe. No Chairman will risk his résumé and reputation on this endeavor. They all know the name Havenstein and Greenspan! Better continue current policies and leave the “big one” to a future Chairman or maybe woman!
As a side note, the fact that President Obama has a hard time getting a viable candidate to the very job every economist on the planet usually desire speaks volumes about the state the economy.
Now that interest rates has begun to react intuitively to monetary policy decisions, that is interest rises on taper-talk and falls on non-taper, as opposed to what we experienced in earlier QE-programs, the FOMC has painted themselves into a corner.
They know the flow aspect of their policy adds to financial misallocation, but they cannot get out of it without re-setting the whole financial system.
In enter another devious scheme. What if they could “talk down rates” through so called forward guidance? In an attempt to have their cake and eat it too, they will provide economic forecasts showing recovery on track, while at the same time create the illusion that interest rates will be low.
In the latest update, FOMC believe the US economy will be back on full steam by 2016, but still, they try telling the public that the Fed funds rate will be 2 per cent!
Source: Federal Reserve, own calculations
The tiny feeling of crisis that came from the taper announcement in May was enough to scare the FOMC board into submission.
However, as we have shown here several times, it will be impossible for the FOMC to withdraw, let alone deleverage, without real consequences.
Also, by consuming output from wealth creators, continuation of the program will not lead to genuine growth and never reach so-called escape velocity.
So what to do? Do what every politician does. Continue current policies in the hope things will not blow up before the next in line will have to deal with it.