Preparing for the Apocalypse?


Federal Reserve policy must seem pretty arcane to most people, which is why I try to liven it up with a bit of sarcasm and wit. There was a lead article in this week’s Barrons illustrating how the public equity markets are shrinking (instead of the Wilshire 5000, it’s now the Wilshire 3666). Here is the lead-in:

As companies find other ways to raise cash, number of U.S. stocks keeps shrinking.

The writer then summarizes an explanation:

Why has the universe of investible U.S. stocks shriveled so? Globalization, porous borders, and the rise of foreign markets have siphoned away a few U.S. listings. Mergers and bankruptcies have exacted a toll. Increased regulation and the climbing costs of a public listing have weakened the resolve of managers who once dreamt of ringing the opening bell at the New York Stock Exchange. At the same time, zealous private-equity buyers and zero interest rates are making it all too easy for companies to raise money without going through the pantomime of public compliance.

This should really surprise no one who’s aware of the impact Fed policy has upon the structure of our economy. Think about it: you start a business with a little capital saved up. If you’re successful and your business grows you need more and more capital, either from the bank, from venture capitalists, private equity firms, or public equity and credit markets (by issuing stocks and bonds). The costs of these different financing options varies. Borrowing at a reasonable or low rate allows one to retain the equity and leverage the profits and value of the enterprise. (This is how one gets into the 1%)

However, if borrowing is dear, growing firms will use public equity markets to spread risk and give up a proportionate amount of return. But Fed policy over the past 20 years has essentially assured business owners that monetary policy will serve to prop up business and equity values with limitless liquidity. That’s what the Fed’s Zero Interest Rate Policy does by keeping interest rates low. (Quantitative easing buys up bad mortgages from the banks so they can get back into the business of making loans, but who wants to make loans when you can make risk-free returns by buying Treasuries and lending to the government?)

So where’s the risk and the imperative to give up equity profits to share that risk? Essentially, the Fed has given businesses and speculators free insurance and leveraged them up with cheap credit. The taxpayers provide the guarantees by absorbing any losses with bailouts.

So, as the article explains, we see private equity and share buybacks shrinking the participation of the public in the profits of capitalism. Why give up equity if there is no risk? It is my opinion that Fed policy is accelerating the imbalances in our market society to unsustainable levels. And the politicians merely think the headline numbers show what a great job they’re doing. The Obama administration is touting the bubbling stock market as proof of how great their policies are working for America. Really? They should think about this: a permanent zero or negative real interest rate essentially means There. Is. No. Tomorrow. Great, shall we call it the Apocalypse policy?


Passing the Torch

G&BNot on our watch!

The advantage of a worldwide system of paper money is—or should be—that market participants observe national policies and adjust interest rates and exchange rates accordingly. Their role is to reward responsible policies that create value and punish foolish policies that destroy value. They do not need bureaucrats by any title to set interest rates and exchange rates.

The Federal Reserve has abrogated its role to political expediency in providing the credit funding of irresponsible and unsustainable government spending. There are no limits? I guess we’ll have to relearn the truths about central banking in a fiat currency world, explained in this week’s Barrons:

The Chair at the Head of the Table


Where does Janet Yellen stand, or sit?

The person who styles herself “chair” of the Board of Governors of the Federal Reserve System was in the hot seat last week. Admittedly, were Janet Yellen to prefer chairwoman or chairman for her title, it would make no difference to the legion of monetary skeptics who expect nothing but the worst from her supervision. Nevertheless, her assumption of the pseudo-title of chair, by which she makes obeisance to clumsy gender politics, is not an encouraging sign of future success.

Nor did we find much reason for optimism in the chairwoman’s opening report to the House Banking Committee and the Senate Finance Committee.

Although Yellen impressed some observers as unusually clear in her report and testimony, that could be an illusion deliberately created. Yellen is widely taken to be an inflationist, more interested in the number of jobs in the economy than in the value of the money paid to the workers. This is normal for an academic economist and not so dangerous for a vice chairman who controls only one vote, but a Fed ruler who wants to try to control money and the economy dares not have an obvious ruling philosophy.

It’s hard enough for any leader to follow the Fed’s contradictory mandates, seeking, among other things, maximum employment, stable prices, and a secure financial system, without making the impossibility obvious by the excessive use of clarity.

If those who speculate in currencies and bonds know what Fed policy will be, the head of the Fed will have less power to talk the markets up or down, and that’s a power that the last three chairmen of the Fed cherished and tried to expand. They were successful enough that a leading Washington newspaper last week could describe Yellen’s new job as being “steward of the nation’s economy.”

Understand, however, that talking the markets up and down is not a good use of a chairperson’s eloquence, and that the economy does not need a steward, especially not a steward whose sole real power is to create money.

The advantage of a worldwide system of paper money is—or should be—that market participants observe national policies and adjust interest rates and exchange rates accordingly. Their role is to reward responsible policies that create value and punish foolish policies that destroy value. They do not need bureaucrats by any title to set interest rates and exchange rates.

The central bank should follow a simple rule, such as Milton Friedman’s advice to raise the money supply by a specific small amount every month, or John Taylor’s advice to respond to increased inflation by raising real interest rates proportionately.

Most central bankers, however, believe it is their job to manipulate markets with interest-rate policies supported by empty words. In the short term, they can fool speculators, but the truth will out, and the truth will create disillusionment and cynicism, leading eventually to disaster. In the case of the U.S., the short term has lasted for decades, but that does not mean that there is no such thing as disaster.

Experience teaches that the only way to stop central bankers from deceiving the markets is to make them stop talking.

Yellen should roll back former Chairman Ben Bernanke’s open, transparent communications policy as fast as she can. The boss of the Federal Reserve should have little or nothing to say to the public, because the public is not her constituency—not even the unemployed part of the public. Her appropriate responsibility is to provide monetary stability to the economy, not soothing words for political stability. The chairwoman or chairman should be as silent and apolitical as the chair she or he sits on at Fed meetings.

How To Increase Inequality

wealth gap

wealth gap2

Just continue with the Obama-Federal Reserve-Treasury policies of the past five years.

The middle class and the poor are being taken for a ride by the political hit men in Washington D.C.  The concern expressed for rising inequality and the middle class are directly contradicted by the policy actions these same politicians have taken. The Federal Reserve is funding the patronage machine in D.C. and the financiers and politicians are benefiting. This is your government at work.

From the WSJ:

…when the next financial bubble bursts with horrible consequences for the real economy—average Americans will pay the biggest price.

The Markets Love Yellen—for Now

The new head of the Federal Reserve says monetary policy won’t change, unless it does.

By Judy Shelton

Janet Yellen proved on Tuesday that she has mastered the art of Fed-speak. Testifying before the House Financial Services Committee for the first time as the chairwoman of the Federal Reserve, she said she expects “a great deal of continuity” in policy, including the “taper” of the Fed’s quantitative easing, while saying the bond-buying program is “not on a preset course.” Markets cheered, with the Dow Jones Industrial Average surging nearly 200 points.

Ms. Yellen is the 15th head of the Fed since its establishment a century ago. She inherited an extremely difficult predicament from predecessor Ben Bernanke. The stock market’s volatility since the first of the year has awakened fears that the Fed’s efforts to improve economic performance through its bond-buying and near-zero interest-rate policy have worked instead to distort capital flows and misprice financial assets.

Is it possible that economic growth has actually been impaired by the Fed’s unconventional monetary policies? Can the world’s dominant central bank continue each month to purchase $65 billion in Treasurys and mortgage-backed securities without doing further damage? If it tapers further, does it risk sparking global financial turmoil?

Worries about the boom-and-bust consequences of manipulating interest rates are nothing new. The perils of monetary “stimulus” were hotly debated in the 1930s by economists John Maynard Keynes and Friedrich Hayek. When confronted with rising unemployment amid economic depression, the political compulsion to act results in higher government spending and easy money.

But over time, does government intervention retard the natural workings of free markets to deliver prosperity? This question is at the heart of any discussion about the appropriate role of the Federal Reserve. One hopes Ms. Yellen will address it when she testifies before the Senate Banking Committee on Thursday.

In 1913 the Federal Reserve’s relatively modest purpose was to provide emergency supplies of currency to local banks to satisfy unanticipated customer demands for cash. The nation was still on a gold standard, so the notion of deliberately expanding or contracting the money supply to affect economic performance wasn’t considered a viable government option.

The Fed’s rise to prominence and influence really began in 1935 under President Franklin Roosevelt. The year before, Roosevelt had devalued the dollar from $20.67 to $35 per troy ounce of gold by executive proclamation. Now he initiated a reorganization of the Fed that would shift power from regional bank districts to Washington, D.C. Roosevelt appointed Marriner Eccles as chairman of the Fed’s Board of Governors and authorized him to conduct national monetary policy through the newly centralized banking system.

Eccles was initially an advocate for government stimulus to spur the economy during slack periods to reduce unemployment. He embraced the Keynesian formula for running government deficits and surpluses over the business cycle. But he became increasingly uncomfortable the following decade with the assumption that the Fed would forever absorb excess government spending by injecting more money into the system—and thus inflict future higher prices on the population. By the time Eccles stepped down in 1948, he was fiercely opposed to the administration’s inflationary war financing.

The lesson Ms. Yellen might draw from the Eccles experience—his name adorns the Fed’s formidable headquarters on Constitution Avenue in Washington—is that stimulus isn’t meant to be permanent. At some point government expenditures must be paid for with tax revenues.

Even as Ms. Yellen insists that the Fed is pursuing “highly accommodative” monetary policy to achieve specific economic growth objectives, it is clear that her approach also bails out federal deficit spending. She can hardly argue that emergency conditions still warrant extraordinary measures by the Fed—especially after testifying that economic recovery has “gained greater traction” in the past seven months. It has been 4½ years since the recession presumably ended. So why is Ms. Yellen sticking with the notion that the Fed intends to suppress interest rates far into the future?

During the nomination process, President Obama made it clear that, given a choice between reducing unemployment or keeping prices stable, he wanted a Fed chief who would lean toward the former. Unfortunately, this makes it more difficult for Ms. Yellen to convincingly assert the independence of monetary policy from political considerations.

During Tuesday’s hearing, she referred several times to the need to raise the inflation rate to 2% or even higher—which means her definition of price stability would let the dollar lose more than 20% of its value each decade. Ms. Yellen might keep in mind what happened to Arthur Burns, who ran the Fed under President Richard Nixon and was considered a Republican loyalist.

While Burns was an eminently qualified economist, his reputation was tarnished by the perception—borne out by the Nixon tapes—that he succumbed to presidential pressure to conduct expansionary monetary policy to spike economic growth in the run-up to the 1972 election.

Paul Volcker took over the Fed in 1979, a tumultuous period as inflation ultimately reached 13.5% in 1981 before it was squeezed out through monetary discipline. If Ms. Yellen were to listen to Mr. Volcker, she might get a different take on whether tension actually exists within the Fed’s so-called “dual mandate” to achieve both maximum employment and price stability.

“I find that mandate both operationally confusing and ultimately illusory,” Mr. Volcker said in a speech to the Economic Club of New York last year. “It implies a trade-off between economic growth and price stability, a concept that I thought had long ago been refuted not just by Nobel Prize winners but by experience.”

Then again, Ms. Yellen is credited with successfully convincing Alan Greenspan that mild inflation does little harm, and is actually a good thing. She was relatively new to the Fed Board of Governors in 1996, but Fed meeting transcripts reveal that Ms. Yellen talked then-Chairman Greenspan out of his goal of driving inflation down to zero. In true Keynesian fashion, she reasoned that workers want higher nominal wages even when higher prices negate them; better to accept the money illusion benefits of 2% inflation than to risk slipping into a deflationary spiral with rising unemployment.

It is ironic that concern for wage earners serves to justify money pumping by the Fed that ends up largely benefiting people who have hefty stock-market portfolios, especially at a time when “income inequality” is a major White House theme.

Perhaps one of our elected representatives on Capitol Hill can explain to Ms. Yellen that when the low-grade fever of perpetual inflation becomes a full-blown economic malady—when the next financial bubble bursts with horrible consequences for the real economy—average Americans will pay the biggest price.


Unfortunately, almost all our elected representatives are in on the game. Most of them have hefty stock portfolios and can legally trade on inside information based on pending legislation. Can you see something wrong with this picture?

Party Likes It’s 1999


It’s becoming impossible to refute that our economic fate is being determined by feckless monetary and fiscal policies from Washington. Total reserves have ballooned 60 times? Where’s all the money? In the asset speculation casino. The reason US financial assets are so desirable is because the rest of the world is trying to follow the Fed’s lead, but investors know when the music stops, the US will be the best place to have your money and the gamblers will own the US by virtue of owning all those US$. This will not end well for most.

From the WSJ:

In her first Congressional appearance as Chairman of the Federal Reserve, Janet Yellen cheered Wall Street with her promise to continue the easy-money policies of predecessor Ben Bernanke.

While Ms. Yellen’s Senate testimony today is likely to attract more media attention, we’d say this week’s most important speech from the Federal Reserve system came last night in Texas.

Before a gathering of financial executives, Dallas Fed President Richard Fisher quantified how much money the central bank has been pumping into the economy. Mr. Fisher said that total reserves of depository institutions “have ballooned from a precrisis level of $43 billion to $2.5 trillion.” He added that “the amount of money lying fallow in the banking system is 60 times greater now than it was at year-end 2007. One is hard pressed to argue that there is insufficient money available for businesses to put people back to work.”

“It is my firm belief,” he continued, ” that the fault in our economy lies not in monetary policy but in a feckless federal government that simply cannot get its fiscal and regulatory policy geared so as to encourage business to take the copious amount of money we at the Fed have created and put it to work creating jobs and growing our economy. Fiscal policy is not only ‘not an ally of U.S. growth,’ it is its enemy. If the fiscal and regulatory authorities that you elect and put into office to craft taxes, spending and regulations do not focus their efforts on providing incentives for businesses to expand job-creating capital investment rather than bicker with each other for partisan purposes, our economy will continue to fall short and the middle-income worker will continue being victimized, no matter how much money the Fed prints.”

Bernanke’s Legacy

bernanke-titanic-cartoonKey here is this the graph below showing total debt as a percentage of GDP. It’s been rising steadily since 2001 and accelerated under Bernanke’s tenure. It now approaches 150% of GDP, showing how  Bernanke’s policies have saved the financial sector by shifting unsustainable private (household) sector debt to the public (government) sector and the taxpayer. So, irresponsible borrowers as leveraged speculators in housing, etc. have been rewarded at a cost to many who were prudent and responsible with their financial commitments. What a great way to promote long-term economic stability and growth. What a legacy.

From the WSJ:

How Will History See Bernanke’s Legacy?

Friday Jan. 31 is Ben Bernanke’s final day at the Federal Reserve after eight years at the helm, and Fed watchers of all stripes are weighing in on his legacy.

The Journal’s Jon Hilsenrath dug into the chairman’s tenure in an article late last year: “After a financial crisis he didn’t see coming, Ben Bernanke steered the U.S. away from a potentially devastating panic. Yet five years later, the recovery he helped engineer with extraordinary policies remains frustratingly weak,” Mr. Hilsenrath wrote.

“That legacy — a mix of failings, boldness, persistence and frustration — is coming into sharper focus, and with it a clearer picture of the power and limitations of modern central banking. ”

In a column last month, David Wessel described how Mr. Bernanke left a lasting mark on the Fed: “Mr. Bernanke has succeeded in changing an institution once so committed to secrecy that a 1985 book dubbed it “an intentional mystery.” Twenty years ago, the Fed didn’t even disclose when its policy committee had decided to move interest rates, let alone explain why. [In December], the central bank issued a 694-word statement as well as economic forecasts stretching to 2016.”

Mr. Hilsenrath and Mr. Wessel discussed Mr. Bernanke’s legacy in this video:

Mr. Bernanke also had a lasting impact on markets. The Journal’s E.S. Browning parsed the legacy from an investors’ point of view: Mr. Bernanke “still has plenty of critics who accuse him of misguidedly distorting the economy. Even admirers worry about the huge, uncertain task that remains: withdrawing the unprecedented Fed support on which markets now rely. But many professional investors are acknowledging, sometimes grudgingly, that Mr. Bernanke has gone a long way toward achieving the main goal he set in 2008: He has stabilized markets and restored a large measure of investor and public confidence. Many thought it impossible that he would accomplish what he did.”

In his effort to stabilize the economy, Mr. Bernanke took the central bank into unprecedented territory. The following graphic shows the tools the Fed used to influence the economy under his watch (Click for larger version):

Those tools have affected the economy in a variety of ways, some intended and some not. (Click for larger version)

Professional economists surveyed by the Wall Street Journal graded Mr. Bernanke with a solid B for his time as chairman of the Fed. Looking back on his legacy, the forecasters took a kindlier view of his performance. As the Journal’s Pedro Nicolaci da Costa noted: “His final grades improved significantly from a December 2012 poll, when he averaged a disappointing ‘C.’”

The general public says Mr. Bernanke is leaving office less popular than his predecessor Alan Greenspan was when he stepped down.  About 40% approve of the way Mr. Bernanke has handled his job as chairman, versus 35% who disapprove and 25% who have no opinion, according to a Gallup poll. Alan Greenspan stepped down with a 65% approval rating in 2006, before the financial crisis.

The Journal also asked five prominent economists to write about how they imagined Mr. Bernanke will be remembered. Among them, Lars E.O. Svensson, former Deputy Governor of the Riksbank wrote, “Ben Bernanke most likely saved the US and probably the world from the Great Recession turning into the Great Depression II,” wrote. But not everyone was so sanguine. “Purchasing long-term securities — quantitative easing — lowered longer rates but because the Fed paid interest on excess reserves, the banks were discouraged from lending, hindering recovery. These policies formulated by discretion rather than rules threaten the Fed’s credibility and independence, and Bernanke’s legacy,” wrote Michael Bordo, Board of Governors Professor of Economics, Rutgers University and Visiting Distinguished Fellow, The Hoover Institution.

Other critics are even harsher. Economist Steve H. Hanke wrote for the Cato institute that Mr. Bernanke deserves a failing grade for his handling of the economy: “Prof. Bernanke’s days at the Fed have been marked by monetary misjudgments and malfeasance. Since the proof of the pudding should be in the eating, zero stars in the Michelin Guide.”