Every so often, someone decides to pick a fight with me over the Federal Reserve. They say I’ve got it all wrong. They say the Fed is going to prove its mettle. They say that foreign central banks are crying “Uncle” over the dollar, and that this will force the Fed to reverse course and start raising rates.
Folks, that’s just hokum.
Pick whatever term you’re comfortable with!
To those who argue otherwise, I would simply reply that you have to get into the “Fed’s head.” You have to understand what’s driving their approach to policymaking. The underlying principle is this: They are more afraid of a relapse in the economy than any big outbreak in inflation.
Fed Speeches Make it Clear That
Easy Money Is Here to Stay
|Gold continues to hit new highs as worried investors dump the dollar.|
The Fedheads who are in power right now are Ivory Tower policy wonks. They simply do NOT care that oil prices have more than doubled off their lows … that gold is zooming to new highs almost every day … or that the dollar is circling the drain.
Instead, they’re the type of people who IGNORE market signals like those. They focus on traditional economic indicators, such as figures on capacity utilization, unemployment, and consumer prices.
Don’t believe me? I can’t understand why. Every few days, we get even MORE reinforcing proof that I’m on the right track.
Take Fed Vice Chairman Donald Kohn. He just gave a speech in St. Louis to the National Association of Business Economics. In describing the economy, he had the following nuggets to share …
“The substantial rise in the unemployment rate and the plunge in capacity utilization suggest that the margin of slack in labor and product markets is considerable …
“Businesses have been aggressively cutting costs not only by eliminating jobs, but also by cutting back increases in labor compensation …
“Even as the economy begins to recover, substantial slack in resource utilization is likely to continue to damp cost pressures and maintain a competitive pricing environment. I expect that the persistence of economic slack, accompanied by stable longer-term inflation expectations, will keep inflation subdued for some time …
“The financial headwinds are likely to abate slowly, restraining the economic recovery.”
There’s nary a mention of market signals … nor a hawkish statement among them. Kohn is clearly not “prepping the battlefield,” so to speak, for an interest rate hike.
Or how about St. Louis Fed President James Bullard? He said in a Bloomberg radio interview on Monday that “you want to see the economy start to recover in all its dimensions, output and trade” before you raise interest rates.
|Judging by the minutes of their recent meeting, it seems that the Fed just doesn’t care.|
In English, that means the Fed won’t raise rates until unemployment starts dropping notably. Bullard went so far as to say that a falling unemployment rate was a “prerequisite” to boosting interest rates.
The problem with that thinking is that unemployment is a lagging indicator. Inflationary pressures could already be building — and the asset markets could already be bubbling out of control — long BEFORE the unemployment rate drops sharply.
Meanwhile, the just-released minutes of the Fed’s late September meeting show that officials were actually considering INCREASING the size of their mortgage purchase program!
The Fed has already committed to buy a whopping $1.25 trillion of mortgage-backed securities to drive rates lower. That version of “quantitative easing” is hammering the dollar, and the market had been looking for a signal the Fed might back off.
So judging from the minutes … the Fed just doesn’t care.
Fed Mantra: Avoid the Great
Depression-Style “Double Dip”
You simply have to understand that the Fed is operating from the “Great Depression” playbook. They’re deathly afraid of a 1937-38 type scenario where, they believe, tighter monetary policy helped contribute to a substantial double dip in the U.S. economy.
This is what I call the “Paul Krugman” view. The Nobel Prize-winning economist (who writes for The New York Times) reiterated in South Korea this week that he thinks it’s way too early to cut back on the “Free Money, Now and Forever” regime. Specifically, he said:
“Under the best of circumstances we’re going to have years before we return to anything that approaches reasonable levels of employment in the major advanced economies … that means staying with these very nonstandard policies for an extended period. It means keeping interest rates close to zero for a very long time.”
|The Fed’s irresponsible monetary policies are squeezing the life out of the dollar.|
I will tell you flat out that this is going to end in disaster! The Fed has now helped inflate two gigantic asset bubbles with its reckless easy money policies. I have zero doubt they’ll screw it up again — and that things will blow up in our faces … again.
But you simply can NOT jump the gun. The next bust will only occur when policymakers change course, the bond market blows up, or we get, say, a concerted effort to bolster the greenback by virtually every central bank in the world.
I see zero signs of that happening. So as long as that’s the case, and the Kohn-Krugman school of thought is guiding policy in Washington, you have to stick with the carry trade mentality.
That means you can’t really short the stock market for more than a quick trade, and in select special situations. You have to favor emerging market stocks and foreign bonds. You have to write the dollar off. And you have to stick with gold and other hard assets that can hold their value in a free-money regime.
Until next time,
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