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Next-Generation Crazy: The Fed Plans For The Coming Recession

Interest-Rates / Recession 2018 Nov 19, 2017 - 12:17 PM GMT

By: John_Rubino


Insanity, like criminality, usually starts small and expands with time. In the Fed’s case, the process began in the 1990s with a series of (in retrospect) relatively minor problems running from Mexico’s currency crisis thorough Russia’s bond default, the Asian Contagion financial crisis, the Long Term Capital Management collapse and finally the Y2K computer bug.

With the exception of Y2K – which turned out to be a total non-event – these mini-crises were threats primarily to the big banks that had unwisely lent money to entities that then flushed it away. But instead of recognizing that this kind of non-fatal failure is crucial to the proper functioning of a market economy, providing as it does a set of object lessons for everyone else on what not to do, the Fed chose to protect the big banks from the consequences of their mistakes. It cut interest rates dramatically and/or acquiesced in federal bailouts that converted well-deserved big-bank losses into major profits.

The banks concluded from this that any level of risk is okay because they’ll keep the proceeds without having to worry about the associated risks.

At this point – let’s say late 1999 — the Fed is corrupt rather than crazy. But the world created by its corruption was about to push it into full-on delusion.

The amount of credit flowing into the system in the late 1990s converted the tech stock bull market of 1996 into the dot-com bubble of 1999, which burst spectacularly in 2000, causing a deep, chaotic recession.

Instead of letting this (also well-deserved) crisis run its course, the Fed again protected Wall Street by cutting interest rates to unprecedentedly-low levels, something that rational observers warned would cause another bubble of some kind. Sure enough, the resulting housing bubble expanded to epic proportions before popping in 2007, with results that most readers remember clearly.

The Fed then completely lost it, setting short-term interest rates at literally zero and buying trillions of dollars of bonds to push long-term rates down to record low levels. This lit a rocket under asset prices, enriching the banks and their wealthy clients while saddling the rest of society with debilitating student loan, car, house and credit card debt. Again – to observers outside the Keynesian bubble delusion – this was not sane behavior. But in the context of an overriding compulsion to save Wall Street at any cost, it was sold – and bought – as somehow heroic rather than pathological.

Which brings us to today, 9 years into the latest bubble-driven recovery with debts everywhere at record levels, stocks and bonds priced for perfection, and interest rates still at historically low levels. Now the Fed is making plans for the next, inevitable recession. And not surprisingly, given the past three decades’ trajectory, those plans are even crazier than their predecessors:

Some thoughts
Think of the Fed – and the other major central banks – as a person who does a stupid but not necessarily criminal or pathological thing, and then starts committing ever-more serious crimes to cover up the original act. Each new atrocity is justifiable in the moment, since it keeps the perpetrator out of jail, but the later stages of the process seem criminally-insane to rational bystanders. Here’s some of what the Fed is planning and why it’s bad:

  • Negative interest rates are a distortion of markets that imply a fundamental misunderstanding of the purpose of markets, which is to efficiently allocate capital. When savings generates a negative return, as they do when bonds and bank accounts charge rather than pay interest, capital shrinks rather than grows. There is no possibility of “efficient allocation” when returns are negative.
  • “Evans said the Fed must alter its statement to make clear that its inflation target of 2% is not a ceiling.” One of the hallmarks of obsession is a fixation on one thing to the exclusion of everything else. The Fed official quoted here is living in a world where real estate, bond and stock prices are at record levels, and consumer, corporate and government debt is soaring. And where a painting, wristwatch, and piece of paper with a single line of text recently sold, respectively, for $450 million, $17 million, and $1.8 million. And he sees unacceptably-low inflation.
  • “Strategies that central banks should consider including not only the bond-buying and forward guidance used widely in the last recession, but also negative interest rates that was used in some non-U.S. countries, as well as untried tools including so-called price-level targeting or nominal-income targeting, he said.” Price-level targeting, since it focuses on the wrong prices, will simply blow up even bigger asset bubbles (thus illustrating another definition of insanity: repeating the same activity while expecting a different outcome).

    And nominal-income targeting? Here again, it’s easy to raise the average income by enriching the 1%, but using negative interest rates (which lower the incomes of small savers) and asset purchases (which bypass small savers who lack big stock and bond portfolios) to help society as a whole is worse than pointless. Which is another sign that the Fed literally doesn’t see the biggest part of the economy — financial asset prices — because those prices aren’t accounted for in its “aggregate demand” economic models.

Anyhow, the list of delusions and other pathologies could go on for a while. Suffice it to say that when the next recession hits – which, based on the action in junk bonds, subprime mortgages and the yield curve, may be fairly soon – some truly crazy ideas will be dumped on a still (amazingly) unsuspecting public.

By John Rubino

Copyright 2017 © John Rubino - All Rights Reserved

Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2018 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.

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