Federal Reserve is Getting Nervous

President Barack Obama often touts his administration’s achievements relating to the economy. Often the President uses the decreasing unemployment figure and the strength of the equities’ markets as proof statements.  Both are red herrings.

The unemployment figures are ginned-up by the government to back a chosen narrative.  In recent years of this rate has been reduced mainly by Americans dropping out of the workforce and therefore not counted as unemployed.  In addition, Americans have been forced to take less than full-time work.

As stock prices have shown in recent weeks, what goes up will come down.  The Dow Jones Industrial Average is down this year by 1,800 points or approximately 10%.  This significant drop has occurred even though the Federal Reserve has maintained historically low interest rates for nearly 8 years.

The Federal Reserve today released a statement indicating that it too was concerned with the direction of the economy.  In a statement released today, the Fed said: “The [Fed] is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.”  This typical Fed gibberish that in simple English means the economy is shaky.

The Federal Reserve’s near zero interest rate policies created an economy that is out of balance.  Cheap interest rates have not fueled real economic growth, but instead created financial bubbles, as exemplified by equity valuations.  This has placed the Fed in a quandary.  If the economy weakens, the Federal Reserve will either have to allow the forces of supply and demand to correct the imbalances; i.e. a significant recession, or use even more radical easy money policies to keep the party going.  Realistically, the only ammo left in the Fed’s arsenal is negative interest rates.  The implications of banks requiring payments from depositors for savings deposits are hard to imagine.

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Economic Growth Anemic Despite Governmental Interventions

When the economic meltdown occurred eight years ago the government used the crisis as an excuse for interventions that included huge bailouts and significantly increased deficit spending.  These radical interventions were justified by the threat without them significantly greater economic damage would occur.  While even in hindsight it is difficult to determine the validity of those claims, there is enough history to understand that the interventions created long-term negative consequences to the economy.

A recent posting by Van R. Hoisington, Lacy H. Hunt, Ph.D. titled A Weak Finish to a Disappointing Year shares details about some of the consequences from the governmental and Federal Reserve’s interventions.  They include:

  • “Surely the economy would be kick-started by: three rounds of quantitative easing and forward guidance; a record Federal Reserve balance sheet; and an unprecedented increase in federal debt from $9.99 trillion in 2008 to $18.63 trillion in 2015, a jump of 86%. Further, stock prices had gained sufficiently over the past several years, thus the so-called wealth effect would boost consumer spending.”
  • “The broadest and most reliable measure of economic performance – nominal GDP – decelerated. The 3% estimated gain registered in 2015, measured by the year ending quarter, was down from 3.9% and 4.1%, respectively, in 2014 and 2013.  In fact the gain in nominal GDP in 2015 was less than the gain for any year since the recession.”  ….. “All of the above economic measures were expanding at, or near, their weakest yearly growth rates in the final quarter of 2015, indicating that the economy possessed little forward momentum moving into 2016.”
  • “Personal consumption, the largest category of nominal GDP, decelerated to an estimated 3% rise in the latest twelve months, down from 4% at year-end 2014, the smallest year end annual increase since immediately after the 2008-09 recession.”
  • “The percentage of total auto loans in the subprime category hit a ten-year pre-crisis high in the third quarter, according to the New York Fed”
  • “Industrial production slumped 1.4% over the first eleven months of 2015, with a drop of 2% outside of the automotive sector.”
  • Real per capita GDP grew only 1.3% in the current expansion that began in mid-2009; this is less than one half the growth rate in the expansions since 1790.”

As Hoisington and Hunt point out, the evidence points to the failure of the massive spending, bailouts and other unconventional monetary policies including Quantitative Easing (QE).  QE has been used multiple times by the United States Europe and Japan. The failure of these policies is evident. Continue reading

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Subprime Loans are Back Again

It was just six years ago that the world was at the brink of economic Armageddon.  The crisis was brought on by the cheap loans made available to borrowers including those rated as subprime with credit scores below 640.  The cheap mortgages to those with limited assets helped create a huge bubble in the housing market.  When the economy slowed down and home values began to depreciate, many borrowers began to default on the mortgages, which placed at risk major financial institutions worldwide that invested in these bundled mortgages.

Banks and others that owned the collateralized mortgages then required bailouts from the government to stave off failure.  This did not eliminate the debt, but merely moved it from the private sector to governments; i.e. taxpayers.  In addition, the bailouts inordinately benefited companies and their shareholders who made the imprudent loans.  Without the bailouts they would have encountered substantial financial losses.

There is also been a more incipient result of the bailouts of investors who made imprudent loans in the subprime market.  Without suffering losses investors have had short memories and in fact they are back at it again in the subprime financing business, once again supported by low interest rate central-bank policies with interest rates worldwide remaining at artificially and historic lows.

Last month, the Wall Street Journal highlighted the growth of subprime loans in an article titled Borrowers Flock to Subprime Loans.  Today, subprime loans are not in the housing market, but in consumer goods.  The Journal published the following:

  • Subprime loans are at the highest level since before the 2008 financial meltdown.
  • Approximately 4 out of every 10 loans for autos, credit cards and other personal borrowing in 2014 were in the subprime category.
  • During the fourth quarter of 2014, total US household debt increased by over $300 billion.

Continue reading

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Fed’s Yellen Primes Pump

Federal Reserve Chairperson, Janet Yellen, today announced that Fed will continue its low interest rate policy for some time into the future. Many had expected Yellen to indicate that with the improving economy, the Fed would begin a slow rise in interest rates. Yellen’s commitment of more gin in the punch bowl had an immediate effect with the Dow Jones Industrial Average, S&P 500, and the UK’s flagship FTSE 100 all hitting recordYellen highs.

Generally, rising stock markets are positive signs if the rise is based on appropriate economic fundamentals.   The lengthy drive-up of equity values are instead being driven by the Fed’s low interest rates and Quantitative Easing. This is problematic at various levels. First, should there be an economic slowdown, as there inevitably will, the Fed would have no ammo left to juice up the economy. In addition, when interest rates eventually rise, overvalued equities will show a rapid decline in value causing significant economic pain.

Perhaps the most problematic aspect of the Federal Reserve’s low interest rate policies is who benefits from them. While some on mainstream benefit as equity values rise, especially in 401(k) plans, the greatest benefit goes to the highest income brackets, the people who have the most to invest. This has led to the large increase in the income disparity in the United States. The Fed’s continuation of its policies will further increase the disparity.

Finally, the Fed’s low interest rate policies have cajoled investors into higher risk investments in search of yield. This places further upward pressure on equity values as the bubble builds and guarantees that the next downturn will be exasperated by these interventionist policies.

For many months government publish statistics has shown a significantly improving economy. In addition, by the classical definition, the recession ended years ago. These two items seem in conflict with Janet Yellen’s announcement today that the economy is still fragile. Either the government’s published figures or Yellen’s comments of earlier today relating to the economy need to be questioned.

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What is Money?

For some years conservative economists have voiced opinions that the easy money policies of the Federal Reserve and the increasing deficit spending by the United States will damage the economy.  As the years pass and without clear connection between these policies and their costs or consequences, these calls have begun to sound more like the girl that cried wolf.  However, unless one believes in perpetual motion or alchemy, there must be costs to policies that in essence print money.

Forbes Editor-in-Chief Steve Forbes has said of money:

Money is simply a tool that measures value, like a ruler measures length and a clock measures time.  Just as changing the number of inches in a foot will not increase the building of houses or anything else, lowering the value of money will not create more wealth.  The only way we will ever get a real recovery is through a return to trustworthy, sound money.  And the best way to achieve that is with a gold standard: a dollar linked to gold.  Continue reading

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