The Un-Credible Fed
By
William Fleckenstein
Feb 25, 2008 1:45 pm
Problems too big to bailout.
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The other day I was musing that perhaps the Fed has lost the bond market. Meaning that the Fed is understood to be fueling inflationary fires, and even though it can take short rates down, it won't be able to affect long rates.
Of course, making a statement like that is always bold, because you're never going to know if it's true until well down the road. And, even though that statement may look like it's true in the short run, it may in fact not be.
That said, I've been struck by the media's recognition (finally) that we have an inflation problem. And, given its understanding that the Fed is clearly in a box -- destined to ease (in an attempt to stave off economic weakness), while continuing to honor the Greenspan put (as far as equities go) -- folks are now beginning to realize that the Fed's predicament will only increase the inflationary pressures.
Of course, the Fed will say that if the economy weakens, it will take pressure off inflation. And, a tanking of world GDP would do that to some degree. But this would only be of limited help. A serious amount of economic weakness would be needed to counteract the money-printing that has chased the price of almost everything higher. This is the psychological component that Jim Grant called "money of the mind" (which he wrote about so eloquently in his book of the same title).
It takes many years for a certain psychological mindset to plant roots, and generally that state of mind is resistant to change. But it does appear that psychology regarding inflation has changed, and that the Fed is in the process of losing the bond market. One has only to look at the explosive rise in 30-year fixed-rate mortgages to see that the Fed' campaign of easing has backfired. A knowledgeable friend in that business tells me this is one of the worst periods ever, as those rates have just rocketed higher, even as the Fed has eased.
Greenspan and the Fed created this mess by picking the wrong interest rate -- and by continually bailing out every problem created by excess money-printing with more excess money-printing. But we're finally at the moment in time where the problems are too big to bail out (periodic upside flurries in stocks and belief in magic wands notwithstanding).
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Reply
2008-02-25 14:03:44
Bill,
Thanks for your article.
This seems to be the opposite of Greenspan's "conundrum" of a few years ago, that while he was raising short term rates, long term rates actually went down.
I still have not read anyone understanding what led to this paradox, but I think I read somewhere that Greenspan thought it may have been due to Asia (China primarily) buying our bonds that kept the rates low. Of course they did this for very altruistic reasons but there was a concern at the time that when China eventually tired of getting less of a return on investment they would pull there money out of of the U.S..
My question is this:
Is the rapid rise in long term rates due to Banks simply hoarding money (as discussed in numerous instances on this site) or is it due to the evaporation of foreign investors in U.S. long bonds?
Thanks for your article.
This seems to be the opposite of Greenspan's "conundrum" of a few years ago, that while he was raising short term rates, long term rates actually went down.
I still have not read anyone understanding what led to this paradox, but I think I read somewhere that Greenspan thought it may have been due to Asia (China primarily) buying our bonds that kept the rates low. Of course they did this for very altruistic reasons but there was a concern at the time that when China eventually tired of getting less of a return on investment they would pull there money out of of the U.S..
My question is this:
Is the rapid rise in long term rates due to Banks simply hoarding money (as discussed in numerous instances on this site) or is it due to the evaporation of foreign investors in U.S. long bonds?
2008-02-26 00:26:15
inflationista vs deflationista -- 15 rounds
glad to see the opposite side of the deflationista argument here.
technically, inflation is here and more is staring us all in the face.
so why do so many writers on this board hunt for the magic beans of deflation?
in fact i write this at all because i'm almost taken over by their arguments! but now i'm taken back to the reality of the now. thanks.
how about you and a deflationista do a point/counterpoint? lets really flesh this one out...
gotta go, i heard $50's are falling from some helicopter nearby...
2008-02-26 10:29:16
Actually this isn't against the deflationista argument at all
The first person that I read that predicted this was Mish. When the Fed started cutting, he pointed to the yield spreads, mortgages and TIPS (maybe, or it could have been someone else that agreed with him that looked at TIPS) and concluded that it wasn't inflation that would lead to the yields, but increased risk of default. He said that the government couldn't bail out anything because if they did it would cause the interest rates to go even higher and make the problem worse.
He brought up Kenneth's point and said that the Fed was completely powerless to affect interest rates on the long side of the curve, and since that's ultimately what matters, faith in them was misplaced.
Here are a couple of the links
http://globaleconomicanalysis.blogspot.com/2007/08/will-rate-cuts-save-economy.html
http://globaleconomicanalysis.blogspot.com/2007/09/yield-curve-bear-steepener.html
He brought up Kenneth's point and said that the Fed was completely powerless to affect interest rates on the long side of the curve, and since that's ultimately what matters, faith in them was misplaced.
Here are a couple of the links
http://globaleconomicanalysis.blogspot.com/2007/08/will-rate-cuts-save-economy.html
http://globaleconomicanalysis.blogspot.com/2007/09/yield-curve-bear-steepener.html
2008-02-26 18:03:09
The Fed's Mandate: Taking a Higher View
Though it's easy to criticize the actions of the Fed, it might be remembered that the nature of this beast has always been to promote financial socialism, for better or worse. It was constructed as such.
From a perspective of viewing free market capitalism as the only truly progressive force, which I hold to be true, there is no deliberate action that such a powerful institution can take that could truly be considered right, other than to simply act mechanistically. From the alternative perspective of those with a more socialistic bias, the Fed can just never do enough.
In any case, as in war and politics, a countless many will be negatively impacted during turbulent times, whatever the cause, and so the Fed errs simply in acting. The King may or may not act benevolently, but can he ever really be right? It's very hard to say when virutally everyone and everything is inevitably to be affected.
Milton Friedman's argument that monetary policy should be formulaic (i.e., not involve human decision-making) and Alan Greenspan's now ironic academic arguments for a gold standard (while a much younger and more idealistic man) clearly say as much.
Historically, fear of economic collapse, however justifiable, has always bred calls for government action and/or socialistic opportunism. This certainly applies to the current situation, as it did to the creation of the Federal Reserve System, for better or worse.
In such times it helps to remember that, in terms of promoting progress and providing immunity from widespread economic hardship, one has yet to construct and prove out a monetary/financial system that works better within any political framework than what we've had. It also helps to recognize that every contraction we've experienced has appeared at its worst and been argued by many to be the end of society as we knew it.
Whatever the form and actions of more or less centralized banking in this country, it seems that each time we've fallen into an economic trough - the great depression included - we've found it followed up by a new, unprecedented, and widespread economic high, however painful and scary has been the interim process.
And, however pessimistic is one's perspective, in this way we seem to continue along a very, very bumpy but ulimately constructive course. In that regard, the only questions that remain to be asked are whether you and yours have been able and willing to fasten your economic seatbelts, and, if so, whether, in the spirit of good will, you might have any you would be willing and able to spare upon condition with others.
From a perspective of viewing free market capitalism as the only truly progressive force, which I hold to be true, there is no deliberate action that such a powerful institution can take that could truly be considered right, other than to simply act mechanistically. From the alternative perspective of those with a more socialistic bias, the Fed can just never do enough.
In any case, as in war and politics, a countless many will be negatively impacted during turbulent times, whatever the cause, and so the Fed errs simply in acting. The King may or may not act benevolently, but can he ever really be right? It's very hard to say when virutally everyone and everything is inevitably to be affected.
Milton Friedman's argument that monetary policy should be formulaic (i.e., not involve human decision-making) and Alan Greenspan's now ironic academic arguments for a gold standard (while a much younger and more idealistic man) clearly say as much.
Historically, fear of economic collapse, however justifiable, has always bred calls for government action and/or socialistic opportunism. This certainly applies to the current situation, as it did to the creation of the Federal Reserve System, for better or worse.
In such times it helps to remember that, in terms of promoting progress and providing immunity from widespread economic hardship, one has yet to construct and prove out a monetary/financial system that works better within any political framework than what we've had. It also helps to recognize that every contraction we've experienced has appeared at its worst and been argued by many to be the end of society as we knew it.
Whatever the form and actions of more or less centralized banking in this country, it seems that each time we've fallen into an economic trough - the great depression included - we've found it followed up by a new, unprecedented, and widespread economic high, however painful and scary has been the interim process.
And, however pessimistic is one's perspective, in this way we seem to continue along a very, very bumpy but ulimately constructive course. In that regard, the only questions that remain to be asked are whether you and yours have been able and willing to fasten your economic seatbelts, and, if so, whether, in the spirit of good will, you might have any you would be willing and able to spare upon condition with others.
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