Sooner or later everyone sits down to a banquet of consequences.
~ Robert Louis Stevenson
Last week, the Federal Reserve decided to keep US interest rates unchanged, marking its 96th month of life at the zero bound. Apparently, for all of its “data dependence”, the Fed feels the economy could still benefit from *just* a little more of its ZIRP happy juice.
But as anyone with a little common sense will tell you, More is not always better. It’s quite possible to have too much of a good thing.
BlackRock’s Larry Fink: Not all ETF investors are passive
BlackRock CEO Laurence Fink spoke at Morningstar's recent conference, and he talked about a variety of things, like his concerns about company culture at a time when all the firm's employees are working at home. Despite those concerns, he doesn't think BlackRock will ever be 100% working in the office. He thinks employees will always Read More
And in its pursuit to kick the can for a little more longer, the Fed is crossing a dangerous line. Dangerous not just to the health of our market economy (that line was crossed a long time ago); but to its own existence. A central bank’s authority is based on faith in its power to effect its mandate. Last week’s decision was so toothlessly passive that even the Fed’s cheerleaders are beginning to question if it has any clue for how to escape from the corner it has painted itself into.
The Fed and its central banking brethren (most notably the European Central Bank, Bank of Japan, Bank of England and Bank of China), have decided to sacrifice investing for tomorrow (namely savings, and capital expenditure in productive enterprise) in favor of higher prices today for financial assets. By keeping interest rates historically low — and increasingly negative — around the world, they have pushed capital much farther out the risk curve than it deserves to be. All while adding trillions of more debt into an already dangerously over-leveraged economy, and lavishly rewarding the rich elite at the expense of everyone else.
As Stevenson wrote, sooner or later, the banquet of consequences must be supped on. And for the Fed, the dinner bell is ringing.
The Law Of Diminishing Marginal Utility
Last month, I issued a report titled The Marginal Buyer Holds The Pin That Pops Every Asset Bubble which explained how prices are set “at the margin” (meaning: above what the second-highest bidder is willing to pay). It’s a very useful concept for understanding how prices rise to unsustainable heights during an asset bubble era such as the one we’re in now, and how they can fall much more quickly than most expect when a bubble bursts.
Building further on this viewpoint at the margin, I want to examine the concept of marginal utility. Marginal utility is essentially how much benefit you derive from receiving more of something, usually one more additional unit of a good or service.
On the surface, most of us think: If a little is good, then even more is better, right?
Well, not always. In fact, in most cases not.
As this hokey short video from Investopedia shows, the satisfaction we gain from each additional unit diminishes, until a switchover point is reached at which each new unit is no longer experienced as a benefit, but as a cost:
The pizza example from the video is not dissimilar from the central banking cartel’s intervention efforts over the past decade. With each additional month at historically low interest rates, the goosing effects of ZIRP/NIRP policy to the economy diminishes. Despite a planetary coordinated effort to dish out bigger and bigger pizza slices of monetary stimulus, the global economy can’t manage to grow any faster than its current stumbling pace. World central bank balance sheets have now tripled in size since 2008, and yet global GDP growth has remained stuck at 2.5% for years:
Note the red line in the above chart. The liquidity efforts of the central banking cartel have flooded the world with $trillions and $trillions of debt incremental to the massive pile that existed before the 2008 credit crisis. (Remember, all central bank-issued money is loaned into existence.) As if we needed more: for those who haven’t been paying attention, the world now has about $60 trillion more debt than it did at the end of 2007:
Continued economic growth is requiring more and more debt. In fact, despite the recent jump in debt over the past few years, growth in world trade is petering out:
WTO cuts world trade growth forecast to 1.7% in 2016
World trade will this year grow at the slowest pace since the global financial crisis, a development that should serve as a “wake-up call” given rising antiglobalization sentiment, the World Trade Organization warned Tuesday.
The Geneva-based body responsible for enforcing the rules that govern global trade cut its forecast for the growth of exports and imports this year and next, and now foresees an increase of just 1.7% in 2016 and as little as 1.8% in 2017, having projected rises of 2.8% and 3.6%, respectively, in April.
The WTO joined other international bodies—such as the Organization for Economic Cooperation and Development—in warning a slowdown in trade could weaken longer-term economic growth.
Simply put: We have reached the switchover point at which the costs of additional monetary stimulus exceed any benefits.
It’s at moments like this when the credit-engorged system can no longer be sustained and breakages occur. To put it more visually, the next unit of stimulus is likely to operate as Monty Python’s “wafer-thin mint”:
Yellen Rings The Dinner Bell
Fundamentals don’t pop bubble markets, shifting sentiment does. Bubbles breed off of confidence: confidence that prices will be even better tomorrow than they are today.
For nearly a decade now, the Fed has cultivated an aura of omnipotence; that it has the power to boost economic growth and reduce unemployment — while simultaneously ‘creating’ wealth by elevating the prices of stocks, bonds and real estate. Speculators have loved the security promised by Greenspan/Bernanke/Yellen “put”, trusting that the Fed is working hard to keep the party rollicking. And they’ve been rewarded for their faith: percentage gains across nearly all financial asset classes between 2010-2014 were tremendous.
But since then, things have flattened out. Price appreciation has become harder to come by and the price action has been more choppy. Our central banking high priests and priestesses perform more rain dances, but the rains don’t fall. Despite nearly $200 billion in stimulus being pumped into the global economy each month by the ECB and BOJ alone, growth remains anemic.
Given this failure to boost growth, the natives are growing worried. So it’s little surprise that all eyes were on Janet Yellen last week, as market investors hoped to receive signs that the Fed had a winning card to play. Yellen’s decision to stand pat (really more of a ‘non-decision’ to do anything) gave no such signs. More important, it appears to have stretched the Fed’s credulity to the point where market analysts — even its biggest cheerleaders — are beginning to voice doubts that the Fed has any control left over the situation anymore.
“This is a disaster in terms of credibility,” says Dan North, chief U.S. economist at Euler Hermes. Investors “don’t think there’s any credibility in what [Fed officials] say because there’s too many voices.” (CNNMoney)
“Credibility is out the window and forward guidance is dead,” said Michael Ingram, a market analyst with CMC Markets, based in London. (TheStreet.com)
“I’m choked with emotion and hardly able to speak,” the portfolio manager at Janus Capital Management said in an interview with CNBC’s “Power Lunch.”
“After hawkish talk at Jackson Hole from [Fed Chair] Yellen and [Vice Chair] Stan Fischer, who even said there’d be two hikes in 2016, they’ve chosen to defer once more a necessary hike to normalize short-term interest rates and provide savers, in my view, with at least a bit of thin gruel to work with to provide for education, retirement and health-care needs.”
He believes the contradiction between what Fed officials have said leading up to the meeting and the outcome of the gathering is leaving investors “very confused.” (CNBC)
More and more people are beginning to feel that perhaps our position here at Peak Prosperity has indeed been the correct one all along. That, by intervening with loose monetary policy to prevent the markets from correcting naturally, the Fed has re-blown a series of asset bubbles that have concentrated wealth in the pockets of the top 0.1% at the expense of nearly everybody else, particularly savers and those on fixed incomes. In doing so, it made the financial markets addicted to its cheap and voluminous liquidity, to the point where they threaten to nose-dive every time the Fed or its collective brethren attempt to tighten the stimulus spigot.
Yellen and company have reached the point where they are damned if they tighten, and damned if they don’t. So their best play is to simply stall for time — which, in retrospect, looks like pretty much what the Fed has been doing since the end of QE3 in late 2014.
So the Fed can’t afford to raise rates. But by not doing so, it’s now in violation of the very “data dependent” rules it claims publicly to be bound by. By its own admission, the unemployment rate is now extremely low, “economic activity has picked up from the modest pace seen in the first half of this year”, and household income has jumped. Yet the Fed is still triaging the economy with life support measures. Something is clearly amiss in the gap between the confidence the Fed projects and the desperation of its actual measures.
The dinner bell for the Fed’s banquet of consequences has been rung. It’s credibility is becoming increasingly stretched among mainstream audiences, and should it actually raise rates in December (forget about November, I don’t think there’s anyone left who still believes the Fed is not politicized), it will be vilified by the ensuing market drop. Attacks to its reputation from fringe voices like Ron Paul were easy to deflect, but public shamings on the worldwide stage of the US Presidential election from the Republican nominee are much more threatening:
The Banquet Of Consequences
So, the big question of course is: How will this all end?
In his excellent report last week, Hell To Pay, Chris laid out how once faith in central banks is lost, their power to delay the deflationary day of reckoning goes with it. The stupendous amount of debt they have helped heap onto the financial system since 2008 will start going into default and the only question that will matter is: Who is going to eat the losses?
The daisy chain of bubbles in stocks, real estate, and the mother of them all — the bond market — will pop, adding additional losses to the growing bloodbath.
All this will weigh on the already-sluggish growth in the economy, sending us into deep capital-R Recession, or worse.
So, if you haven’t done so already, read his report (it’s free). And strongly consider taking the precautionary steps he advises, lest you be one of the unlucky forced to choke down the Fed-created losses at the coming Banquet of Consequences.