A subtle shift occurred over the weekend. What we might call "new normal" uncertainty gave way to genuine uncertainty after the Federal Reserve could not bring itself to raise its short-term rate even 1/4 of 1%. Genuine uncertainty leads to fear. Fear leads to panic. Panic has all sorts of bad consequences. This does not bode well for global financial markets or the world economy.
You see, it is a question of legitimacy. Since 2008, the Federal Reserve has been perceived as more and more important to the functioning of the "real" economy. After the initial fiscal stimulus of 2009, which petered out by 2011, the Congress has does nothing to help the Main Street economy. But Congress has very little standing among Americans anymore, who perceive correctly that its decisions do not reflect their best interests.
On the other hand, in terms of system justification theory, the Federal Reserve has been seen as more and more legitimate and important to the public interest.
We argue that there is a general (but not insurmountable) system justification motive to defend and justify the status quo and to bolster the legitimacy of the existing social order.
Such a motive is not unique to members of dominant groups.
We see it as comparable—in terms of its strength and social significance—to widely documented motives to defend and justify the interests and esteem of the self-concept and the social group.
We expand previous theoretical notions and claim that people want to hold favorable attitudes about themselves and about their own groups, but they also want to hold favorable attitudes about social and political systems that affect them.
This "system justification motive" has been so strong in recent months that political liberals, who ostensibly speak for the public interest, not financial interests, have anointed the Fed (its ZIRP policy) as the People's Savior. The Fed has been credited with lowering the unemployment rate to 5.1%, despite weak (if any) evidence to support the role of monetary policy in reducing unemployment.
Despite unequivocal evidence that the Fed's QE policies clearly made America's inequality problem worse, the Fed has gotten a free ride. And finally, there is an obvious incoherence in casting the Fed as all-good and all-powerful, which John Hussman put this way (emphasis his)—
Last week, the Federal Reserve chose to do nothing to move short-term interest rates away from zero after nearly 6 years of extraordinary policy distortion. As detailed below, the inaction of the Fed, and the failure of the stock market to advance in response, follows the script that I detailed in February. Policy makers at the Fed actually appear to believe – contrary to historical evidence and contrary even to the recent experience of numerous countries around the world – that activist monetary policy has meaningful and reliable effects on subsequent economic activity. It’s lamentable that otherwise thoughtful policy makers, much less journalists who cover these actions, show no interest in how weak these correlations are in actual data, and seem incapable of operating even the most basic scatterplot. Despite the spew of projectile money creation around the world, the global economy is again deteriorating. The main defense of the Fed’s inaction seems to be that years of zero interest rate policy have been hopelessly ineffective, so continued zero interest rate policy is necessary.
As we’ve demonstrated previously, there’s no statistical evidence in the historical record to suggest that activist monetary policy has any relationship to actual subsequent economic activity (see The Beauty of Truth and the Beast of Dogma). Historically, monetary policy variables themselves can be largely predicted by previous changes in output, employment and inflation. That “systematic” component of monetary policy does have a weak correlation with subsequent economic changes. It’s unclear whether that’s purely incidental, or whether those systematic changes in monetary variables (such as short-term interest rates) are actually necessary for the weak effects that follow. I should be careful to note that monetary policy also seems to weakly influence confidence expressed in certain survey-based questionnaires. But that correlation emphatically does not translate into changes in actual output, income, or employment. Put simply, massive activist deviations from systematic monetary policy rules provide no observable economic benefit, but instead create fertile ground for speculative bubbles and crashes.
It is indeed "lamentable" that so many members of the dominant elites in the press, among economists and policymakers, etc. have bought into a massive fiction, but system justification—affirming the legitimacy of the current "new normal" social order—has been very, very powerful since the meltdown in 2008.
One would think it needless to say that the Fed is an elite institution which serves at the behest and in the interests of Big Finance, but here I am having to say it. The Federal Reserve bailed out the Big Banks and lots of other shysters after the 2008 meltdown, and still has 1.735 trillion dollars of mortgage-backed "assets" on its books. And who owned (prior to the meltdown) mortgage-backed securities? After the financial crisis, the Federal Reserve did not offer to buy your credit card or mortgage debt.
But now this lamentable trend appears to be coming to an end. It is easy if you're zerohedge to simply assert that Goldman Sachs dictates Fed policy, and since specific predictions have been made, it is also easy to wait & see if they come true (i.e., the Fed will not raise rates until mid-2016, as Goldman wants, and probably not even then because that's only a few months before the presidential election). In short, the typical Flatland story says the Fed never had any legitimacy, at least among fear mongers hoping to drive traffic to their website.
But just in case this paranoid conspiracy interpretation of Fed inaction is wrong, we would be wise to consider other sources. And those other mainstream sources are beginning to doubt the legitimacy of the Fed. Consider CNN Money's Is the stockmarket holding Janet Yellen hostage?
Normally the financial markets dance to the tune of the all-powerful Federal Reserve.
Note the language — the all-powerful Federal Reserve.
But now the tables have turned. The Fed's decision last week to delay raising rates was caused at least in part by turmoil in the financial markets.
"It's not just that they're being held hostage. They've actually volunteered to be hostage to the markets," said David Kelly, chief global strategist at JPMorgan Funds.
All of this is fanning fear that Fed chief Janet Yellen and her colleagues may be trapped at near-zero rates — the level at which they've been since the height of the financial crisis in 2008. Even though we have not been in a crisis scenario for some time, the Fed has hesitated to lift rates. There's always been some reason.
In the last couple of years, the hesitation was fueled by fears that it might kill a fragile economic recovery. Today, the stock market is scaring the Fed. That's a dangerous thought, given how volatile and unpredictable it can be.
Let the craziness begin.
Market forces not economic fundamentals driving policy?
U.S. and global markets plunged in late August over signs that China's economic slowdown was deepening. The fear was that China, long the world's engine of growth, could derail the global economy. At one point the S&P 500 was down nearly 13% from its July peak.
So, though Yellen sounded mostly upbeat about the U.S. economy, she explained the move by specifically pointing to "volatility in financial markets" caused by global growth worries.
Some investors and Fed watchers were startled by the Fed's rationale. They believe it shows outside forces, not economic fundamentals, are now driving policy.
"In nearly 50 years of analyzing the Fed, I've never seen anything like this," said David Jones, a former Fed economist who is now president of DMJ Advisors.
This is a direct assault on the current social order and the legitimacy of the Fed. Even leaving aside the question of whether Fed actions were ever primarily driven by economic fundamentals — do you remember the Greenspan put? — we have a naked emperor if the markets are driving the Fed and not the other way around. It seems that "there's always some reason" why the Fed can not wean the "buy the dip" piglets off the monetary teat. Andrew Sentance pursues this theme at the prestigious Financial Times.
These are tough times for monetary policymakers. That is undeniable. In autumn 2008 and early 2009, the task was easy. Cut interest rates as fast as you can to as low a level as possible. I was one of the guilty men and women that participated in this economic rescue act. But now I see central bankers delaying taking action both in the US and the UK.
The U.S. Federal Reserve decided not to raise the key policy rate in the US this week. That would be an understandable decision if rates were at or close to a normal level. But they are not. Interest rates of 0.5 per cent in the UK and 0-0.25 per cent in the US are the lowest recorded levels in history. Seven years into a recovery, central bankers need to explain why the interest rate playing field is still so heavily tilted to borrowers.
Yes they do.
Continuing with such low interest rates in the UK and the US, when unemployment rates are back to 5-5.5 per cent and our economies are growing well, raises some more profound questions about monetary policy in the west.
First, how independent are central banks?
Good question.
Since the 1990s, the Fed and the Bank of England have pursued policies similar to the ones any well-meaning government official would have chosen. They have cut interest rates very readily, but when they have raised them (in 1994-5 and 2005-7) they have been behind the curve.
Independent central banks were established precisely to avoid this “behind the curve” interest rate policy. But it has not worked. Once again, they are at serious risk of lagging behind in their interest rate decisions as the major western economies climb out of the post-crisis recession.
[With regard to "behind the curve," read John Hussman's commentary quoted and linked-in above.]
Second, if interest rates cannot rise now, when will they increase?
Another good question. Remember, in Flatland lack of "independence" is not usually a conspiracy, e.g., Goldman Sachs dictates Fed policy. The degree of "independence" depends on unconscious group ties (the social groups one identifies with and serves, see the third Flatland essay).
In the case of the US, growth has averaged over 2 per cent for more than six years since the recovery started in mid-2009. Unemployment has halved from around 10 per cent to 5 per cent over roughly the same period. Yet interest rates remain stuck — close to zero. A similar position prevails in the UK.
A multitude of reasons have been advanced for delaying the first rate rise: sluggish growth in all the major western economies in 2011-12; the euro crisis in 2013-14; and now the Fed is citing weak economic growth in China and the impact this has on financial markets.
If you look around hard enough, there can always be a reason for not raising interest rates. But that highlights the key problem. Monetary policymakers are very timid at the moment. They are lions who have lost their roar.
The third problem is that central bankers appear to lack a clear strategy for monetary policy. Their implicit strategy is that interest rates will remain at current excessively low levels — until sufficient evidence accumulates to raise them. But a more realistic approach to keeping monetary policy on a steady and neutral course would involve a gradual rise in interest rates over the next few years. The key debate then should be around the pace and extent of this rise, not whether it should take place at all.
The discussion of UK and US monetary policy is taking place on the basis of a false premise — that we can maintain near-zero official rates indefinitely — and that this would somehow be a satisfactory basis for economic growth over the medium term. I do not believe that, and I do not meet many people in the business and financial world who do either. If they do have a view about long-term near-zero interest rates, it is that this is likely to drag the UK and/or the US into a low growth equilibrium like Japan. That would be a major policy failure for the leading western economies.
Again we have a direct assault on the legitimacy of the Fed. Imagine it — the independence of the Fed has been questioned in the Financial Times! The Holy of Holies! By a former member of the Bank of England Monetary Policy Committee!
As Janet Yellen "explained" the FOMC's non-decision, she brought every conceivable kind of bullshit to bear, thus sowing even more confusion than we already had (Reuters).
Marc Ostwald, FX, rates and emerging markets strategist at ADM Investor Services, summed up the Federal Open Market Committee’s choice this way:
If the FOMC’s objective was to convey confusion, it has succeeded, thereby ploughing a deep furrow of instability and destabilization, and shining a very bright light on the large debt and liquidity trap it and other G7 central banks have spent 7 years crafting.
... a deep furrow of instability and destabilization... shining a very bright light on the large debt and liquidity trap it and other G7 central banks have spent 7 years crafting. Oh, my!
Joel Naroff, from Naroff Economic Advisors, was even more blunt:
All they succeeded in doing was confusing the heck out of everybody. They introduced financial concerns, third-world countries, China, Canada. What the hell does that have to do with the U.S. economy? I’m totally baffled by it.
... Fear, as markets know very well, is a powerful thing. You can be afraid of the unknown and of repeating a mistake, only to find that the fear creates more fear and eventually, paralysis...
After all, it’s not as if Yellen couldn’t have found explanations for raising rates that even the staunchest of opponents would have accepted. And the difference between 0-0.25 percent and 0.25-0.50 percent should not be enough to choke off the world’s biggest and most powerful economy, with core inflation running not far below 2 percent.
Among other things, so-called "disinflation" (low inflation, if not outright deflation) is always used to rationalize Fed paralysis. You may be surprised to learn that core inflation is running at 1.8% year/year, just 0.2% below the Fed target. This fact alone casts doubt on the legitimacy of the Fed, though not for those who make a living rationalizing the status quo. Here's the end of the Reuters commentary.
Many business leaders – although not the chief executives of J.P. Morgan and Goldman Sachs just before the decision — have recommended she get on with it.
Even a clutch of central bankers from emerging markets, whose currencies have been pummeled to multi-year or record lows as the dollar has surged in anticipation of such a move, have very bluntly recommended the Fed get on with the job.
As with so much of central bank policy which pretends to be a lot more complicated than it really is, the reason it hasn’t done so appears to be rather simple. It seems afraid.
Fear is a powerful thing. Yes, it is. The Fed "system justification" story is failing. People are openly questioning the Fed's motives. At best, the Fed seems incompetent.
As I said at the top, genuine uncertainty about monetary policy, now born of Fed illegitimacy, leads to fear. Fear leads to panic. Panic has all sorts of bad repercussions. This latest Fed "decision" does not bode well for global financial markets or the world economy.
The U.S. stock market sold off after the Fed announcement last Friday. Believe me, that's not a sign of good things to come.
Given human nature, as expressed in this latest monetary policy fiasco, and now that we are in the 20th year of the Bubble Era, I am not optimistic. But then again you already knew that. But today I'm a lot more pessimistic about the near-term future than I was last Friday morning.
That said, I'll get off this U.S. economy/Federal reserve kick I've been on lately and return to how humans are destroying the biosphere. About that there is no uncertainty at all.
"Given human nature, as expressed in this latest monetary policy fiasco, and now that we are in the 20th year of the Bubble Era, I am not optimistic. But then again you already knew that. But today I'm a lot more pessimistic about the near-term future than I was last Friday morning."
Sooo..recession, depression, or collapse maybe?
Posted by: Luka | 09/21/2015 at 01:38 PM