Last year on this page I warned of the Federal Reserve as a threat to the stock markets and the U.S. economy […]For more than a year since then the Federal Reserve has been conducting interest rate policy as it did in 1999-2000 – to deliberately cause another U.S. recession.
It would be interesting to take a chart of the Fed Funds rate, and mark the start-end of each chairman’s term. One would also mark the transition from one term to another – i.e. the point where the chairman wasn’t sure he’d be reappointed. The question I’d like to answer is this: given that the Fed has a Keynesian outlook, is it true that the Fed tries to gives the economy “pain” in the early part of the chairman’s term and relaxes when he’s looking for re-election or looking to establish his “legacy”? My guess would be that there is no such relationship – because I assume that the chairmen generally put their economic view before what they view as their own “interests”.
Remember that recessions are often necessary corrections and this may not actually be a bad action of the Fed (inasmuch as that’s possible, maybe a better word would be “irresponsible”). IIRC Greenspan intentionally caused that recession in 1999-2000 to prevent a crash some years later because too much credit was being made available too easily, and banks would have ended up with thousands of delinquent loans and collapsing investments from which they could not recoup their money.
The major problem with the Fed is not that it represents a threat to the stock market, but that it represents a threat to the entire country if mismanaged. In laissez-faire, a single bank can rise or fall depending on the intelligence of its own management, putting only its own depositors and creditors at risk for losses; if the bank management makes a mistake only a small portion of the country suffers a recession and economic restabilization. If someone in the Fed goofs even a little bit, the entire country could be thrown into a recession from which there is no longer any means to recover. It is not moral to tie all banks to the worst judgment of the poorest bank in the country through a Washington bureaucrat.
Salsman speaks against the “corrective” policies, from the standpoint of stock-marketeers; they believe the market will go bullish again without the Fed changing its policy. He’s right that it won’t, however this doesn’t indicate that the market was “correct” to begin with. He doesn’t address the issue of whether investments were actually performing at expected levels or whether they were artificially inflated by too much access to credit which is the only real measure of whether the Fed is performing properly or not.
Remember that recessions are often necessary corrections
Ah, same old, same old…
What? A small “recession” is caused when a bunch of people make ill-advised investments (i.e. all their production is consumed instead of fueling new production), lose their shirts, and the bank has to hike up rates and stop offering as much credit to make up for it. It’s necessary, otherwise they’ll just go out of business.
This bull-market-paranoia of the Fed is caused by the fact that it’s trying to judge the worthiness of all investments, everywhere! No person or organization is up to the task of knowing whether the entire market is rising legitimately or is simply engaged in another spree like the .com “bubble” that sooner or later will end in a crash. So what do they do? They assume that any rise in the market is bad, and must be restrained by a hike in rates, and any fall in the market is bad and must be supported by a drop in rates.
The relationship being postulated is between the yield-spread and the “real” economy. Secondarily, since the stock-market reflects expectations, there is a consequent relationship.
That’s to say: when short-term interest rates are high in relation to long-term interest rates (thereby squeezing companies like banks who borrow short and lend long), it is often (but not always) followed by a real recession in about 4 quarters. (Here is a 6-page Federal Reserve article about the observed correlation between the yield-spread and real-GDP growth.) The stock market, insofar as it dips to reflect the expectations of such a recession, could also be correlated with the yield-spread. [A blog that I follow had a post about a year ago, that addressed the same topic as the Fed paper.]
It seems clear that the Fed is nervous about inflation. It’s also clear that (correctly or incorrectly) the Fed sees the raising of short-rates as the way to check inflation. The big question is: if inflation is going to be significantly higher than it has been, then why has the long-bond not reflected this by a rise in nominal yields? [Greenspan referred to this as a conundrum.] (That last link also shows that the 10-year yield has begun to move slightly upward).
I see Salsman’s major criticism of the Fed as being this: the Fed need not get nervous when it sees the economy growing well; it need not “apply the brakes”; this is for real, not a bubble. Knowing that the Fed will not heed his advice, he predicts that they will try to slow the economy down and might well succeed. Therefore, the stock-market’s dip is a reasonable reaction to the increased probability that the economy will slow down.
However, one can agree with the bulk of the analysis but still come to a different prediction. If CPI starts to come in higher than recent numbers, the long-term yields could rise, making the spread positive once more. If CPI does not rise significantly, and if there are initial signs that the economy is slowing, the Fed could well slash rates again – they seem to like a yo-yo policy.
If CPI does not rise significantly, and if there are initial signs that the economy is slowing, the Fed could well slash rates again – they seem to like a yo-yo policy.
They would; isn’t the Fed in existence largely to “moderate” the “cycle” of boom and bust? They’d see it as natural. If a cycle doesn’t already exist, well, they’ll create one so that they can moderate it! The really general basics of this are covered in CUI, I think.
If a cycle doesn’t already exist, well, [the Fed will] create one so that they can moderate it!
LOL, as priests love sinners.