The Rich Keep Getting Richer At the Country’s Expense
Have you ever wanted to write something really wonky and poignant, and realized the only real use would be to help cure insomnia? It’s sort of how I feel now as I start writing about one of my favorite topics; I mean targets …The Fed. So, I am going to do my best to make this interesting. My first suggestion is to find a nice bottle of wine and pour yourself a glass. At least that way, there is no real downside.
The Fed has two primary jobs, a dual mandate, full employment, and price stability. The first they take really seriously. No one really wants to see people unemployed and, at least until Covid-19 and PPP, not too many people really wanted to be unemployed. Inflation, on the other hand, has been more of an annoyance, a whipping boy that has been used to justify any and all monetary policies designed to foster growth and employment. It was sort of like the old Book of Rules:
Rule 1 – throw as much stimulus through the system as possible;
Rule 2 – refer to Rule 1.
Too Much Money Printing
Under that framework, the Fed has favored excess monetary accommodation for over twenty-five years. It has been a progressive march to lower and lower interest rates and asset purchase policies that flood the banking system, the capital markets and the economy at-large with staggering amounts of liquidity. Sure, there are some positives as I point out below, but the problem is that it does not really work.
Take Japan where interest first reached zero in 1995, and asset purchase programs in various formats have been going on almost as long. In the meantime, what has happened to the Japanese economy since then; pretty much NADA, the big zero. In tennis, they might call it “getting bageled.” And, by the way, one goal of the BOJ was to push inflation higher. For some reason, central banks are afraid of low inflation and its big brother, deflation. Their aggressive policies did not achieve any upward pressure on prices either. Could it be that their prescription does not work?
C’est La Guerre
Oh well, c’est la guerre. Here’s the funny thing, and where I am going to avoid making you feel like you are watching paint dry. These policies are based on standard monetary theory which preaches that lower rates create more growth. I have long argued with central banks and economists that their theory breaks down as rates drop towards zero and massive asset purchase programs are implemented. There is a lot to it but basically my perspective is that ultra-low yields and asset purchase programs like QE result in lower growth, often lower price trajectories and, in general, a pervasive economic malaise.
I sort of understand how Einstein felt when he tried to convince the physicists of the world that Newtonian physics was limited in extent. Unfortunately, as I think many of you know, academics became wedded to their theories and very defensive when challenged.
Stop the Presses! The Printing Presses, That Is
So, what happened? Ali G, our first monetary guru…(my name for Alan Greenspan because he was as comical as Sacha Baron Cohen’s character,) launched us on our march down the same well-traveled path. To what effect you may ask? How about a massive liquidity trade engineered by secretive hedge funds and their trading desk counterparts that brought the global financial system to its proverbial knees! That was then met then with another massive injection of liquidity that calmed things down. For a bit. The result? How about a tech bubble that burst in a spectacular fashion about twenty years ago? The solution?
Another bout of lower rates and monetary accommodation which obviously would be good. WRONG! How about causing the greatest economic crisis since the Great Depression? Much of the blame was placed on subprime lending but, let me be clear, that was the symptom, not the cause. A subprime crisis of the size and scope we experienced could only have happened because the cost of money and risk were too low. The consequences permeated the financial system bringing the world economy to the brink of Armageddon.
Central Banks…CASINOS in Action: Telling Gamblers “Go ALL-IN!”
And what happened next? Zero rates, negative rates, massive government programs designed to remove secure, low-risk assets from the financial system effectively flooding the system with staggering liquidity. First, central banks bought government securities, then mortgages, then high-grade corporate bonds, and now even low investment-grade securities and equities are considered fair game. Our central banks, rather than being the lenders and liquidity providers of last resort, are now subprime lenders and hedge funds. They are now the casino telling the gamblers to throw caution to the wind and go all-in.
And what has all of this wrought? Let’s be clear, not really too much. In the investment world, it has created something we refer to as “moral hazard”. It encourages investors to ignore, even flouts, risk. Why not when the Fed Chairman acts like Regis Philbin once did on “Who Wants to Be a Millionaire?” protecting every bad decision with an investment lifeline. Obviously, because it encourages bad decision-making and, often bad behavior, eventually resulting in suboptimal outcomes. (I am trying to be respectful here). Economic decision-makers need to have a healthy respect for risk in every decision they make. Transparency, one of the Fed’s modern tools, is a very bad idea indeed.
The same can be said for our generally fiscally prudent legislators; oops, I meant to say…profligate. And, at least when it comes to the power of the purse, irresponsible. Because the cost of money is kept artificially low, Congress (and States) are encouraged to spend and borrow with reckless abandon. When I was young, a Senator named Everett Dirksen used to say, “a billion here, a billion there and pretty soon it adds up to real money.” It sounds like we need to offer the same type of advice Number 2 offered Dr. Evil; “Sir, you mean Trillion.”
On the economic front, global economies have been scraping the bottom for more than a decade. The list includes Japan, continental Europe, the United Kingdom, and, of course, the United States. Upward pressure on prices (at least as measured and focused on by the monetary authorities, a topic for another day) has not really been a big problem.
Distort and Destabilize
I will admit, not everything has been terrible as employment, particularly in the United States, migrated to very low levels. However, the real beneficiary of this deluge of monetary accommodation has been to push asset prices to extraordinary levels. While this may feel good if you own a lot of stock, it comes with a lot of attendant baggage. As noted, it distorts virtually all aspects of financial and economic decision-making. It distorts and destabilizes. The concepts of risk and leverage are swept under the rug. Decisions become short-term in nature. Stability goes out of the window and is replaced by wild swings. Investment and capital become less efficient. The economy becomes an addict to the heroin being pumped through the system. In the meantime, nation after nation has witnessed a massive build-up of debt limiting options to invest for the future. And as to the stock market, it becomes a sword of Damocles hanging by a thread waiting to impale an ill-prepared economy.
Each Crisis Grows Worse – Yet, the Rich Get Richer
When crises finally come, and they invariably do, they are more and more dangerous taking more and more of the drug to revive the patient. While the pandemic is not of monetary origin, the staggering amount of stimulus applied was partially necessitated by the accumulated monetary stimulus of the past. Furthermore, equities are not held broadly enough to lift all boats. As we are seeing, the narrow contingent of truly high-net worth individuals are okay. And so are people with good pensions and benefits, but that insures mostly to older people. Younger people have relatively little exposure to equities as do people at the lower end of the economic spectrum. The Fed has used equities as a measure and tool of monetary policy, although they won’t acknowledge it, believing that higher asset prices stimulate consumption and other economic variables. They ignore the unequal impact, the distortions, and the dull economic trajectories that have accompanied these policies hand in hand back into the last century.
It is probably too late, but central banking needs to go back to its more traditional roots. Provide a framework that encourages the best long-term economic outcomes, tying return to risk, and staying out of the private sector. Even if intervention is necessary, in times of true extremes, such power should be wielded with great care and withdrawn as quickly as possible.