The Fed Is “Chasing The Wind” – Today’s Tightening Will Trigger The Next Crisis Response
Futility with Purpose
Plebeians generally ignore the tact of their economic central planners. They care more that their meatloaf is hot and their suds are cold, than about any plans being hatched in the capital city. Nonetheless, the central planners know an angry mob, with torches and pitchforks, are only a few empty bellies away. Hence, they must always stay on point.
Watch for those pitchfork bearers – they can get real nasty and then heads often roll quite literally. [PT]
One of the central aims of central planners is to achieve effective public exhortation. While they pursue futility, in practice. They must do so with focus and purpose.
For example, economic reports with impressive tables and charts, including pie graphs, are important to maintaining the requisite public perception. Central planners know that financial scientism must always be employed as early and often as possible.
Statistics, with per annum projections, particularly those that show increasing exports and decreasing imports, are critical to maintaining the proper narrative. The USA’s embarrassing deficit in the balance of international payments will certainly diminish if it is sketched accordingly in an “official” report… right?
Yet the planners always disregard the simple observation that an economy is composed of countless, and variable, inputs. How is a new discovery or technology, and its effect on investment and labor, to be anticipated and forecast? How are the actions of 7 billion individuals to be modeled and displayed on a tidy diagram?
Good old Friedrich A. Hayek – depicted above – once coined the term “scientism” to describe the futile attempts of assorted social engineers and their academic advisors to express human action in the form of barren mathematical equations and statistics. Lettuce look at something one of his followers, the late Professor Austin L. Hughes, wrote in an article published in the autumn 2012 issue of “The New Atlantis” journal: “The fundamental problem raised by the identification of “good science” with “institutional science” is that it assumes the practitioners of science to be inherently exempt, at least in the long term, from the corrupting influences that affect all other human practices and institutions. Ladyman, Ross, and Spurrett explicitly state that most human institutions, including “governments, political parties, churches, firms, NGOs, ethnic associations, families … are hardly epistemically reliable at all.” However, “our grounding assumption is that the specific institutional processes of science have inductively established peculiar epistemic reliability.” This assumption is at best naïve and at worst dangerous. If any human institution is held to be exempt from the petty, self-serving, and corrupting motivations that plague us all, the result will almost inevitably be the creation of a priestly caste demanding adulation and required to answer to no-one but itself.” [PT]
Amid the Madness
This week Federal Reserve Chairman Jay Powell delivered the latest installment of the Fed’s public exhortation. The occasion was the Federal Open Market Committee (FOMC) meeting statement and press conference. Before we get to Powell’s remarks, however, some context is in order…
Nearly a decade ago, when Lehman Brothers vanished from the face of the earth, and black swans relentlessly descended upon credit markets like common ravens upon fresh Southern California road kill, something utterly ridiculous happened. Money market shares of the Reserve Primary Fund did the impossible. They broke the buck – falling to $0.97 cents a share.
Amid the madness, Ben Bernanke, the Fed Chair at the time, in what he later characterized as a courageous act, soiled his pantaloons… and then he soiled them again. He cut the federal funds rate to practically zero and began ravenously consuming toxic mortgage backed securities and Treasury notes, ultimately taking the Fed’s balance sheet from roughly $900 billion to over $4.5 trillion by early 2015.
Pedal to the metal: central bankers in panic mode, all hitting the “Ctrl P” key command to save the inherently insolvent fractionally reserved banking system. [PT]
Now, as Fed Chair, it’s Powell’s job to mop up Bernanke and Janet Yellen’s odorous mess. This mop up effort has generally been proceeding as follows…
In December 2015, after seven years of zero interest rate policy, the Fed raised the federal funds rate a quarter of a percent. Then, in December 2016, they did it again. Last year, the Fed increased the federal funds rate three times, by a quarter of a percent each time. So far this year, the federal funds rate has been increased twice – with two more increases anticipated before year’s end.
But that’s not the only mop up work the Fed’s doing. Starting in October 2017, the Fed began contracting its $4.5 trillion balance sheet. If they’re following their stated plan, the balance sheet should now be shrinking by $50 billion per month. Have you noticed that the status of the ongoing balance sheet reduction operation is not mentioned in FOMC meeting statements?
A close-up of the recent decline in assets held by the Federal Reserve system. [PT]
Chasing the Wind
On Wednesday, and within the above stated context, Fed Chair Powell delivered the FOMC’s latest remarks. As expected, the federal funds rate was raised a quarter of a percent to a range of 1.75 to 2 percent. The Fed also clarified that it is their intention to hike rates two more times this year.
Powell also reaffirmed the Fed’s mandate to foster maximum employment and price stability, which, for reasons unclear, they consider to be 2 percent price inflation. Of course, he didn’t mention the Fed’s unstated mandate: To keep the big banks flush with credit and contrive a risk-free market where they can always borrow short and lend long, and pocket the spread for providing the world with the indispensable service of debt – and asset bubbles – without limits.
All this is well and good, especially if you are a lender. But it supposes that the Fed’s whole attempt to plan the economy is within a framework of something that is completely under their control. This is patently false.
US CPI, the Federal Funds rate and the supposed “target” for CPI – which after having been missed to the downside for a while is recently missed to the upside. The extent of “control” de facto seems to be roughly zero. Of course, if rate hikes and the shrinkage of the Fed’s balance sheet continue, prices will eventually respond – in particularly the giant asset bubble central banks have blown in recent years is set to deflate with a bang (once that happens they will panic again). [PT]
The experience over the past century has demonstrated time and time again that the economy is beyond the Fed’s control. In fact, the Fed’s efforts to control it, via credit market intervention, actually compels the economy to convulse and recoil in spectacular ways.
Raising the federal funds rate and reducing the balance sheet are, without question, mopping up the same liquidity that has floated up the stock market indexes well beyond what an honest man could possibly comprehend. This is also the same liquidity that has floated residential real estate prices above the epic 2006 high-water-mark. What will happen to these extremes in asset prices when the liquidity that has floated them up recedes?
At the moment, Powell is raising the federal funds rate so that he can later cut it when the economy inevitably contracts. Similarly, he is reducing the balance sheet so that he can later increase it when the yield curve inverts and the big banks need another great big bailout. No doubt, today’s tightening policies will trigger tomorrow’s crisis response.
Case-Shiller Index of US home prices: the bubble has been resurrected – hurrah! One guess what will happen next… [PT]
These, folks, are facts of life in the year 2018. The Fed is chasing the wind… and taking us all for a wild smash-up ride.