Best of the Week
Most Popular
1. US Housing Market Real Estate Crash The Next Shoe To Drop – Part II - Chris_Vermeulen
2.The Coronavirus Greatest Economic Depression in History? - Nadeem_Walayat
3.US Real Estate Housing Market Crash Is The Next Shoe To Drop - Chris_Vermeulen
4.Coronavirus Stock Market Trend Implications and AI Mega-trend Stocks Buying Levels - Nadeem_Walayat
5. Are Coronavirus Death Statistics Exaggerated? Worse than Seasonal Flu or Not?- Nadeem_Walayat
6.Coronavirus Stock Market Trend Implications, Global Recession and AI Stocks Buying Levels - Nadeem_Walayat
7.US Fourth Turning Accelerating Towards Debt Climax - James_Quinn
8.Dow Stock Market Trend Analysis and Forecast - Nadeem_Walayat
9.Britain's FAKE Coronavirus Death Statistics Exposed - Nadeem_Walayat
10.Commodity Markets Crash Catastrophe Charts - Rambus_Chartology
Last 7 days
Gold’s Major Reversal to Create the “Handle” - 5th July 20
Gold Market Manipulation And The Federal Reserve - 5th July 20
Overclockers UK Custom Build PC Review - 1. Ordering / Stock Issues - 5th July 20
How to Bond With Your Budgie / Parakeet With Morning Song and Dance - 5th July 20
Silver Price Trend Forecast Summer 2020 - 3rd Jul 20
Silver Market Is at a Critical Juncture - 3rd Jul 20
Gold Stocks Breakout Not Confirmed Yet - 3rd Jul 20
Coronavirus Strikes Back. But Force Is Strong With Gold - 3rd Jul 20
Stock Market Russell 2000 Gaps Present Real Targets - 3rd Jul 20
Johnson & Johnson (JNJ) Big Pharma Stock for Machine Learning Life Extension Investing - 2nd Jul 20
All Eyes on Markets to Get a Refreshed Outlook - 2nd Jul 20
The Darkening Clouds on the Stock Market S&P 500 Horizon - 2nd Jul 20
US Fourth Turning Reaches Boiling Point as America Bends its Knee - 2nd Jul 20
After 2nd Quarter Economic Carnage, the Quest for Philippine Recovery - 2nd Jul 20
Gold Completes Another Washout Rotation – Here We Go - 2nd Jul 20
Roosevelt 2.0 and ‘here, hold my beer' - 2nd Jul 20
U.S. Dollar: When Almost Everyone Is Bearish... - 1st Jul 20
Politicians Prepare New Money Drops as US Dollar Weakens - 1st Jul 20
Gold Stocks Still Undervalued - 1st Jul 20
High Premiums in Physical Gold Market: Scam or Supply Crisis? - 1st Jul 20
US Stock Markets Enter Parabolic Price Move - 1st Jul 20
In The Year 2025 If Fiat Currency Can Survive - 30th Jun 20
Gold Likes the IMF Predicting a Deeper Recession - 30th Jun 20
Silver Is Still Cheap For Now - 30th Jun 20
More Stock Market Selling Ahead - 30th Jun 20
Trending Ecommerce Sites in 2020 - 30th Jun 20
Stock Market S&P 500 Approaching the Precipice - 29th Jun 20
APPLE Tech Stock for Investing to Profit from the Machine Learning Mega trend - 29th Jun 20
Student / Gamer Custom System Build June 2020 Proving Impossible - Overclockers UK - 29th Jun 20
US Dollar with Ney and Gann Angles - 29th Jun 20
Europe's Banking Sector: When (and Why) the Rout Really Began - 29th Jun 20
Will People Accept Rampant Inflation? Hell, No! - 29th Jun 20
Gold & Silver Begin The Move To New All-Time Highs - 29th Jun 20
US Stock Market Enters Parabolic Price Move – Be Prepared - 29th Jun 20
Meet BlackRock, the New Great Vampire Squid - 28th Jun 20
Stock Market S&P 500 Approaching a Defining Moment - 28th Jun 20
U.S. Long Bond: Let's Review the "Upward Point of Exhaustion" - 27th Jun 20
Gold, Copper and Silver are Must-own Metals - 27th Jun 20
Why People Have Always Held Gold - 27th Jun 20
Crude Oil Price Meets Key Resistance - 27th Jun 20
INTEL x86 Chip Giant Stock Targets Artificial Intelligence and Quantum Computing for 2020's Growth - 25th Jun 20
Gold’s Long-term Turning Point is Here - 25th Jun 20
Hainan’s ASEAN Future and Dark Clouds Over Hong Kong - 25th Jun 20
Silver Price Trend Analysis - 24th Jun 20
A Stealth Stocks Double Dip or Bear Market Has Started - 24th Jun 20
Trillion-dollar US infrastructure plan will draw in plenty of metal - 24th Jun 20
WARNING: The U.S. Banking System ISN’T as Strong as Advertised - 24th Jun 20
All That Glitters When the World Jitters is Probably Gold - 24th Jun 20
Making Sense of Crude Oil Price Narrow Trading Range - 23rd Jun 20
Elon Musk Mocks Nikola Motors as “Dumb.” Is He Right? - 23rd Jun 20
MICROSOFT Transforming from PC Software to Cloud Services AI, Deep Learning Giant - 23rd Jun 20
Stock Market Decline Resumes - 22nd Jun 20
Excellent Silver Seasonal Buying Opportunity Lies Directly Ahead - 22nd Jun 20
Where is the US Dollar trend headed ? - 22nd Jun 20
Most Shoppers have Stopped Following Supermarket Arrows, is Coughing the New Racism? - 22nd Jun 20

Market Oracle FREE Newsletter

AI Stocks 2020-2035 15 Year Trend Forecast

A New Fed Playbook for the New Normal

Interest-Rates / US Bonds Sep 18, 2014 - 11:00 AM GMT

By: Peter_Schiff

Interest-Rates

While many economists and market watchers have failed to notice, we have entered a new chapter in the short and checkered history of central banking. This paradigm shift, as yet unaddressed in the textbooks, changes the basic policy tools that have traditionally defined the sphere of macroeconomic decision-making.


The job of a central banker is supposed to be the calibration of interest rates to achieve the optimal rate of growth for any particular economic environment. It is hoped that successful decisions, which involve perfectly timed moves to raise rates when the economy overheats and lower them when it cools, would bring consistency and stability to the business cycle that many fear would be dangerously erratic if left unmanaged. That's the theory. The practice is quite different.

Over the past thirty years or so, interest rates have been lowered far more often than they have been raised. This makes sense. Bankers, being human, would rather err on the side of good times not bad. They would rather leave the punch bowl out there a little too long than take it away too soon. Over time, this creates a huge downward bias. But things have really become distorted over the past eight years, a time period during which interest rates have never gone up. They just go down and stay down.

Back in the early years of the last decade, Alan Greenspan ventured into almost unknown territory when he lowered interest rates to 1% and left them there for more than a year. But in today's terms, those moves look hawkish. In the wake of the 2008 financial crisis, Ben Bernanke brought interest rates to zero, where they have remained ever since.

But old habits die hard, and economists still expect that rates can and will go back to normal. They assume that since the economy is now apparently on solid footing, the period of ample accommodation is over. In reality, we have built an economy that is now so leveraged that it needs zero percent interest rates just to tread water.

Based on statistics from the Bureau of Economic Analysis, from 1955 to 2007 Fed Funds rates were on average 230 basis points higher than average GDP growth (5.7% vs. 3.4%). But from 2008-2013, Fed Funds rates have been less than half the rate of GDP growth (0.44% vs. .92%). Rates lower than GDP, in theory, should stimulate the economy. But instead we are stuck in the mud.

Twenty-odd years ago the textbooks still seemed to work. A recession hit in 1991, which brought GDP close to zero. In response, the Fed cut rates by more than 200 basis points (from 5.7% in 1991 to 3.5% in 1992.) As expected, 1992 GDP rebounded to a reasonably healthy 3.6%. But the rate cuts did little for asset prices. In that year the S&P 500 crept up just 4.4% and the Case-Shiller 10-City Composite Index of home prices actually fell almost 2% nationally.

Compare that to 2013. With Fed Funds still near zero, GDP actually fell to 2.2% from 2.3% in 2012. But asset prices were a different story. Stocks were up 26% and real estate up 13.5%. It would appear that interest rates have lost their power to move GDP and can now only exert pressure on asset prices. As a result, rates are no longer the main attraction in central banking. The real action takes place elsewhere.

The Fed and other central banks have made the active purchase of financial assets, known as quantitative easing, to be there main policy tool. QE is a more powerful drug than interest rates. It involves actual market manipulation by the purchases of bonds on the open market. Whereas zero interest rates could be compared to a general stimulant, QE is a direct shot of adrenaline to the heart. When the next recession comes, the syringe will likely come into greater use.

Since 1945 the U.S. economy has dipped into recession 11 times. The average length of the recoveries between those recessions was 58.4 months, or just under five years. The current "recovery" is already 73 months old, or 15 months longer than the average. How will the Fed deal with another contraction (which seems likely to begin within the next year or two) with rates still at or very close to zero? QE appears to be the only option.

Given that reality, the big question is no longer whether the Fed will raise or lower rates, but by how much they will ramp up or taper off QE. When the economy contracts, QE purchases will increase, and when the economy improves, QE will be tapered, and may even approach zero for a time. But interest rates will always remain at zero or, at the least, stay far below the rate of inflation. This will continue until QE loses its potency as well.

Mainstream economists will be quick to dismiss this theory, as they will say that policy is now on course for normalization. Although economic growth in 2013 was nothing to write home about, the set of indicators that are normally followed by most economists, point to a modest recovery, exuberant financial markets, and falling unemployment. But if that is the case, why has the Fed waited so long to tighten?

The truth is the Fed knows the economy needs zero percent rates to stay afloat, which is why they have yet to pull the trigger. The last serious Fed campaign to raise interest rates led to the bursting of the housing bubble in 2006 and the financial crisis that followed in 2008. This occurred despite the slow and predictable manner in which the rates were raised, by 25 basis points every six weeks for two years (a kind of reverse tapering). At the time, Greenspan knew that the housing market and the economy had become dependent on low interest rates, and he did not want to deliver a shock to fragile markets with an abrupt normalization. But his measured and gradual approach only added more air to the real estate bubble, producing an even greater crisis than what might have occurred had he tightened more quickly.

The Fed is making an even graver mistake now if it thinks the economy can handle a measured reduction in QE. Similar to Greenspan, Bernanke understood that asset prices and the economy had become dependent on QE, and he hoped that by slowly tapering QE the economy and the markets could withstand the transition. But I believe these bets will lose just as big as Greenspan's. The end of QE will prick the current bubbles in stocks, real estate, and bonds, just as higher rates pricked the housing bubble in 2006. And as was the case with the measured rate hikes, the tapering process will only add to the severity of the inevitable bust.

So while the market talks the talk on raising rates, the Fed will continue to walk the walk of zero percent interest rates. The action has switched to the next round of QE. In fact, since none of the Fed's prior QE programs were followed by rate hikes but by more QE, why should this time be any different? The most likely difference will be that eventually a larger dose of QE will fail to deliver its desired effect. When that happens, who knows what these geniuses will think of next. But whatever it is, rest assured, it won't be good.

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube

Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital, best-selling author and host of syndicated Peter Schiff Show.

Catch Peter's latest thoughts on the U.S. and International markets in the Euro Pacific Capital Spring 2014 Global Investor Newsletter!

Regards,
Peter Schiff

Euro Pacific Capital
http://www.europac.net/

Peter Schiff Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

6 Critical Money Making Rules