Instability at the Fed
Comment of the Day

April 18 2019

Commentary by Eoin Treacy

Instability at the Fed

Thanks to a subscriber for this report by Daniel Oliver for Myrmikan Research may be of interest to subscribers. Here is a section:

Eoin Treacy's view

Here is a link to the full report and here is a section from it: 

Bernanke executed Reinhart’s plan in 2008, as will Powell and Moore, as would every other non-Austrian school economist as soon as asset markets start to fall in earnest. The only distinction among them is when to start printing, how to do it, and how much to do per episode (matters on which the Fed’s staff make most of the determinations, or at least present the menu). And, let us not forget that the Fed’s self-imposed mandate is no longer to stabilize consumer goods prices but to keep them rising at 2% per year, which requires printing at an even faster rate.

The FOMC announced after its latest meeting on March 20 that the median fed funds forecast of its members was 2.6% through 2021, with the lowest forecast being 2.37%. Meanwhile, the futures markets project a 50% probability that the fed funds rate will be less than 2.25% within a year. In other words, the market is betting the Fed is going to heed Trump and Moore’s demand that it cut, which leads to a thought experiment: imagine the Fed had begun cutting rates in early 1920 or 1929 or 2000 instead of raising them. Owen and Keynes and Friedman and other theorizers argue that doing so would have prevented the debacles. But any practical person operating in business or finance knew that those bubbles were due for a crash—long overdue. Rate cuts at the right time may possibly have extended them and made them worse (as, indeed, happened from 2003–2006), but the crash was coming one way or another.

Anyone operating in today’s financial markets—witnessing the new real estate boom, the “levered loan” orgy, the egregious sovereign debt bubble, the stock market bubble, the private equity mania, the sub-prime auto bubble, the student loan bubble— knows (practically if not intellectually) that the Fed’s “stabilization” policy will result in disaster, bring more QE, tank the dollar, and send gold soaring. If the Fed cuts now, it may be able to delay the next crisis, but that will only make it worse.

There is a consensus view among bond fund managers that the ability of Fed to ease in the next recession will be constrained by the zero bound. That is supported by the belief it has nowhere near as much room for easing as it had in other cycles. In turn that will create the much foretold “pushing on a proverbial string” where efforts to stoke inflation and asset prices will be ineffectual.

That would be true if we limit ourselves to conventional tools but if the last decade has taught us anything it is that central banks will do anything to support asset prices. The conclusion therefore is that there will be a raft of policies deployed, in the event negative rates are deemed insufficient, which are currently thought of as impossible. These include universal basic income or some other helicopter money program, debt cancelation or forgiveness or a mixture of both.

Since these are potentially extremely disruptive scenarios there is a clear incentive for central banks to keep the current bull market going as long as possible, hence the walk-back from raising rates and shrinking the balance, the new LTRO program in Europe and the China’s fiscal impetus.


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