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Archive for the ‘Federal Reserve’ Category

Federal Reserve is Getting Nervous

Posted by Steve Markowitz on January 27, 2016

President Barack Obama often touts his administration’s achievements relating to the economy. Often the President uses the decreasing unemployment figure and the strength of the equities’ markets as proof statements.  Both are red herrings.

The unemployment figures are ginned-up by the government to back a chosen narrative.  In recent years of this rate has been reduced mainly by Americans dropping out of the workforce and therefore not counted as unemployed.  In addition, Americans have been forced to take less than full-time work.

As stock prices have shown in recent weeks, what goes up will come down.  The Dow Jones Industrial Average is down this year by 1,800 points or approximately 10%.  This significant drop has occurred even though the Federal Reserve has maintained historically low interest rates for nearly 8 years.

The Federal Reserve today released a statement indicating that it too was concerned with the direction of the economy.  In a statement released today, the Fed said: “The [Fed] is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.”  This typical Fed gibberish that in simple English means the economy is shaky.

The Federal Reserve’s near zero interest rate policies created an economy that is out of balance.  Cheap interest rates have not fueled real economic growth, but instead created financial bubbles, as exemplified by equity valuations.  This has placed the Fed in a quandary.  If the economy weakens, the Federal Reserve will either have to allow the forces of supply and demand to correct the imbalances; i.e. a significant recession, or use even more radical easy money policies to keep the party going.  Realistically, the only ammo left in the Fed’s arsenal is negative interest rates.  The implications of banks requiring payments from depositors for savings deposits are hard to imagine.


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Federal Reserve Indicates Willingness to Employ Negative Rates

Posted by Steve Markowitz on October 12, 2015

For months the Federal Reserve (Fed) has been “threatening” to increase interest rates from the historic lows.  To date the Fed has come up with a myriad of excuses in delaying any increase.  Given the bubbles created in certain parts of the market including worldwide equities, it is likely that the Fed fears that a rate increase would pop the bubbles leading to significant economic dislocations.

In a world where macroeconomic rules have been turned on their heels, the Fed has floated a trial balloon that is diametrically opposed to their purported goal of increasing rates.  As reported by MarketWatch.com, some in the Fed have indicated a willingness to go to negative interest rates during the next economic crisis; i.e. recession.  In a nutshell, those that put cash in the bank would lose a small percentage of that cash each year, instead of obtaining interest, the historical norm.

New York Fed president William Dudley said in an interview last week: “Some of the experiences [in Europe] suggest maybe can we use negative interest rates and the costs aren’t as great as you anticipate.”  He went on to state: “We see now in the past few years that it has been made to work in some European countries,” and “so I would think that in a future episode that the Fed would consider it.”

It is likely that Dudley’s comments were not a slip of the tongue, but instead a trial balloon to see how markets would react to a radical economic move.  While there has been some softening of the US dollar and increases in commodity prices such as gold, the response has been muted, exactly what the Fed hope for.  This helps demonstrate how far off of economic reality we have come.

Interest RatesTo help put things in perspective, the Federal Reserve refused to implement negative interest rates during the 2009 meltdown, the worst economic calamity since the Great Depression, for fear of the consequences.  The fact that they would consider such action today helps demonstrate just how fragile the Fed views the economy.

The central banks have used historically low interest rates since the 2009 meltdown, as indicated in the attached chart.  Pushing rates to negative returns is a continuation of this policy, although now breaking a psychological barrier, whose goal is to stimulate the economy through increased consumption.  This low interest rate policy has been a failure, which is being confirmed by the Fed’s willingness to go even further.  Why should we expect this additional step would be more successful?

A negative interest rate policy will have unintended economic consequences.  However, there are consequences that are rather easy to foresee:

  • Lower savings for individual Americans will make them even more vulnerable to the consequences of recession.
  • Inflicting economic pain on retirees and others on fixed incomes.
  • Cajoling investors into more risky investments in search of returns.
  • Significantly damaging those dependent on money markets.
  • Decreasing return assumptions for pension plans that will force managers into more risky investments and require additional injection of funds to keep the plans solvent.

New York Fed Chairman Dudley would be willing to pursue the radical negative interest rate policy based on the fact that some European countries have implemented it without major consequences.  However, Dudley ignores the fact that the US dollar is the world’s reserve currency and therefore has broader implications.

We are now approaching the eighth year since the economic meltdown.  We were told that the Fed’s low interest rate policies will repair the damage.  We also have been told by our government that all sorts of stimulus programs and deficit spending would repair the economy.  Both failed, which has resulted in the Federal Reserve announcing the possibility of still more radical programs.  A more prudent approach would be a realistic review of the implemented policies and determine why they failed before implementing more of the same.  But this small piece of logic is either lost on the Fed or they feel that they have no alternative.  Neither offers confidence in the Fed’s ability to navigate these complex issues.


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Fed’s Yellen Primes Pump, Feeds Bubbles

Posted by Steve Markowitz on February 24, 2015

YellenFederal Reserve Chairperson, Janet Yellen, today announced that Fed will continue its low interest rate policy for some time into the future. Many had expected Yellen to indicate that with the improving economy, the Fed would begin a slow rise in interest rates. Yellen’s commitment of more gin in the punch bowl had an immediate effect with the Dow Jones Industrial Average, S&P 500, and the UK’s flagship FTSE 100 all hitting record highs.

Generally, rising stock markets are positive signs if the rise is based on appropriate economic fundamentals.   The lengthy drive-up of equity values are instead being driven by the Fed’s low interest rates and Quantitative Easing. This is problematic at various levels. First, should there be an economic slowdown, as there inevitably will, the Fed would have no ammo left to juice up the economy. In addition, when interest rates eventually rise, overvalued equities will show a rapid decline in value causing significant economic pain.

Perhaps the most problematic aspect of the Federal Reserve’s low interest rate policies is who benefits from them. While some on mainstream benefit as equity values rise, especially in 401(k) plans, the greatest benefit goes to the highest income brackets, the people who have the most to invest. This has led to the large increase in the income disparity in the United States. The Fed’s continuation of its policies will further increase the disparity.

Finally, the Fed’s low interest rate policies have cajoled investors into higher risk investments in search of yield. This places further upward pressure on equity values as the bubble builds and guarantees that the next downturn will be exasperated by these interventionist policies.

For many months government publish statistics has shown a significantly improving economy. In addition, by the classical definition, the recession ended years ago. These two items seem in conflict with Janet Yellen’s announcement today that the economy is still fragile. Either the government’s published figures or Yellen’s comments of earlier today relating to the economy need to be questioned.

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Peter Schiff versus Conventional Wisdom

Posted by Steve Markowitz on August 6, 2014

Peter Schiff is the CEO of Euro Pacific Capital.  He has significant financial expertise that has helped make him a wealthy, the result of being a successful investor.

Schiff is conservative and a proponent of the Austrian School of Economics.  He is looked at as somewhat of a rogue by Wall Street due to his bearish outlook of the long-term view of the US economy and the US dollar, which Schiff contends have been weakened by Federal Reserve policies.

While Schiff‘s views are often controversial, his willingness to go against conventional wisdom and being right makes his ideas worthy of consideration.  For example prior to the 2008 Great Recession caused by the economic meltdown, Schiff went on TV and railed against the Fed’s cheap money policies that he contended created the housing bubble and would ultimately lead its popping.  As seen in the video below, it is remarkable on just how many respected economist and Wall Streeters scoffed at Schiff’s ideas.

Let’s see, Greenspan and his pals at the Fed first did not see the housing bubble being created.  When the downturn started they then predicted that the damage to the economy would be contained.  Greenspan’s successors have since implemented the same easy money policies, but on steroids, that created this economic mess in the first place.

Schiff is once again predicting significant economic turmoil in the near future resulting from the Fed’s ongoing easy money policies.  Most economists disagree.  History, as demonstrated in the video below, has not been kind to conventional wisdom.

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Stock Market Bubble Created by Fed Policies

Posted by Steve Markowitz on July 31, 2014

The 2008 meltdown was largely created by Federal Reserve policies. Since the latter part of the 1990s, previous Fed Chairman Alan Greenspan turned on the spigot of easy money any time there was even minor economic downturns. Historically low interest rates were the favorite tool

The Fed policies damaged the moral hazard leading to irrational investment behavior, as well as poor business judgment especially by banks and other lending institutions. It also led to unsustainable increases in the housing values that created the mother of all bubbles. Not to miss a turn at the punch bowl, governments overspent due to increased tax revenues from the bubble economy.

The Fed doubled down on its easy money policies in response to the 2008 financial meltdown. The consequences are yet to fully play out, but have the potential to be huge.

In a nutshell, the 2008 financial meltdown was caused by excessive debt in the private sector. Through bank bailouts and other governmental interventions, a significant portion of the debt was moved to the public sector; i.e. sovereign debt. With central banks printing money and purchasing the debt, countries including the United States have been able to borrow money at artificially low interest rates creating the illusion of wealth.

There will be a cost and a day of reckoning for the reckless Fed policies. We saw a glimpse of a consequence today when the Dow Jones Industrial Average dropped more than 300 points, nearly 2%. Today’s drop was mainly the result of Argentina defaulting on its debt. Other countries face similar challenges.

Should the world’s financial markets continue to exhibit nervousness, it is predictable as to the Fed’s reaction. They will once again flood the market with more liquidity through quantitative easing. Governments will also have an excuse to expand their deficits with more spending.  This story has been told throughout history and it is never ended well.

Ruchir Sharma, head of emerging markets at Morgan Stanley Investment Management, wrote an op-ed for the Wall Street Journal, Liberals Love the ‘One Percent’, that reviews some of the problems with the Federal Reserve’s policies:

  • While Fed Chairperson Janet Yellen indicated that its policies are designed “to help Main Street not Wall Street,” it has done the opposite. While the current recovery has been the slowest since World War II averaging only 2% annually for the past five years, this has been the most powerful stock market recovery during that same period increasing by 135%. A substantial portion of equity assets are owned by wealthier Americans, which has increased the wealth disparity in the United States.
  • The easy money Fed policies has fed an industry that creates financial instruments to make money on commodity trading and price variations. The best and brightest have learned that there is more money to be made in financial manipulation than inventing and building products.
  • Commodity prices have significantly increased since 2009. On average the increase is 40%, double the rate seen in commodity price increases in recoveries since World War II. In addition, price increases on staples such as food are significantly more problematic for the poor and poor countries, again increasing income disparity.
  • It is likely some commodities are in bubble territory. When they pop, while this will offer relief for those dependent on commodities for subsistence, it will likely lead to financial stress on the financial sector that will lead to a call for more bailouts.
  • Borrowing is often used to finance capital equipment purchases. The current artificially low borrowing costs offer incentives to companies to invest in capital equipment for efficiencies, rather than hire more labor, further depressing the employment.
  • Even some companies flush with cash are barring at the artificially low corporate bond rates and using the funds for less than productive purposes, such as mergers and acquisitions.

As Sharma insightfully concludes, “the Fed can print as much money as it wants, but it can’t control where it goes much of it is finding its way into financial assets”.  Central bankers throughout modern history have proven inept when it comes to proactive policies designed to fix economic distress.  Chairman Greenspan didn’t even see the housing bubble when had already actually popped.  Expecting them to have it right this time is little better than wishful thinking.

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Stephanie Pomboy on Ben Bernanke

Posted by Steve Markowitz on June 1, 2014

Well-known economist, Stephanie Pomboy, made a presentation at the Wine County Conference 2014 posted below. Pomboy reviews a series of charts that demonstrate the failure of Ben Bernanke’s easy money policies.

During the 2009 economic meltdown, the federal government and Fed used the crisis as a pretense for massive interventions. In the early months this included TARP, which bailed out banks that were at financial risk because of their own imprudent behavior. After the election Barack Obama and the Congress passed the massive Stimulus Program. While it is not possible to determine if these programs protected the economy from Armageddon, given the anemic recovery, the slowest since the Great Depression, it is evident that they did not aid long-term economic growth.

Ms. Pomboy specifically takes on the failed Fed easy money programs, mainly Quantitative Easing (QE) that in essence is printing money. The Fed purchased Treasury Bonds in an effort to keep interest rates artificially low under the theory that this helps stimulates economic growth. The slow recovery is one indicator that this effort’s benefit has been marginal.

Easy money policies typically lead to inflation. To date, however, QE has not generated broad-based inflation likely due to the competitive nature of globalization, excess production capacity and depressed demand. However, certain assets significantly inflated including energy, certain foods, and equities. One consequence has been the growing inequity between high net worth individuals and the greater population. Not only are wealthier individuals less impacted by food and energy cost increases, but they benefited more from the increases in equity values. In addition, as food prices increase, the poor in less developed countries go hungry. Some theorizeS&P 500 Interest that the Arab Spring was propelled more by hungry people than those seeking political reform.

Ms. Pomboy refers to a various charts that indicate some of the negative impacts to the economy resulting from Ben Bernanke’s (Fed’s) QE policies. One charts posted shows the benefit large corporations have obtained from artificially low interest rates.  This has increased profits that further propelling equities’ valuations. That Corp Profits Vrs GDPbenefit has flattened more recently and will inhibit these gains and possibly equity values going forward.

Also plotted are corporate profits as a percentage of GDP. This has reached new heights that are unsustainable. The two previous periods that this ratio peaked was before the Dotcom meltdown in 1999 and before the stock market crash of 2008.

Perhaps the most significant chart presented by Pomboy is the one showing the source of funds from which the U.S. Treasury borrows to fund our deficits. Since Quantitative Easing started, the willingness of other countries to buy America’s debt has dropped S&P 500 Interestsignificantly. This trend is unlikely to change with the artificially low interest rates being paid on US Treasuries. There are two likely outcomes to this trend. Either: 1) the United States will have to pay significantly higher interest rates on future borrowings that will force the government to significantly cut spending, or 2) the Fed will have to increase QE to fund the country’s deficits. The second outcome, which Ms. Pomboy predicts, will create significant inflation and place at risk the US dollar’s unique position as the world trading currency. The ramifications of this latter item are quite destabilizing for the American economy.

Ms. Pomboy theorizes, somewhat sarcastically, that Ben Bernanke retired from the Federal Reserve because of his understanding of the dilemma resulting from foreign buyers losing their appetite for US treasuries. Printing money is voodoo economics that has been tried in the past by failed economic models. It is never resolved a country’s long-term problems. The question is not whether there will be consequences, only what they will be.

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US Fed Policies Creates Economic Problems in India

Posted by Steve Markowitz on August 28, 2013

The US government and Federal Reserve have intervened with ever increasing frequency in the economy during the past two decades.  In the 1990’s the US economy had various hick-ups that included the dot.com and telecom bubbles’ and their meltdowns.  Immediately following the 2001 9/11 tragedy a steep drop in economic activity occurred.  In earlier years the Federal Reserve and government would have allowed the law of supply and demand to rebalance the economy.  While painful, such rebalancing is necessary to ensure the proper amounts of goods and services be produced for the available demand.   The interventions, mainly through low interest rate policies and printing money, stopped rebalancing and this ultimately led to the largest bubble of all; the housing bubble.

Five years since the housing bubble popped we continue to see the negative effects of the interventions.  Perhaps the best example is the slowest increase in job growth of any recovery of modern times.

The Fed understands the risks of continuing the low interest rate policy.  It understands that pulling the plug on this “free lunch” is akin to making a drug addict go cold turkey.  In an effort to set the stage for changing the policy, in spring the Fed announced that it is considering lessening its purchase of U.S. Treasury bonds.  That made investors nervous with US equity values gyrating since.  The Fed’s easy money policy is the major reason that US equity prices have inflated during the past two years, not economic growth.  Pull the plug on the easy money and equity values will drop.  It is only question of how far.

The unintended consequences of the Fed’s easy money policies are not limited to the United States.  The Wall Street Journal reported that developing economies are showing significant stress as a result of fears that the Fed will stop buying US Treasury bonds.

  • The Indian stock market lost approximately 5% in value over a two-day period and its currency has dropped significantly versus the US dollar.
  • Thailand has seen its equity markets’ value drop significantly.
  • The Indonesian currency has dropped to a four-year low versus the US dollar and its share prices were down 10% in one week.
  • Malaysia’s currency value has dropped significantly.

The fear is that as interest rates rise investors will pull capital from developing countries and move it to more developed and less risky markets.  As these countries’ currency values drop, their cost of imported commodities such as oil and fertilizer increase.  Inflation in India is currently at an annual rate of about 10%.  Inflation, especially in developing countries, is devastating on the poor who spend most of their money on staples including food.

When the Fed and the US government embarked on the major interventionist policies during the 2008 meltdown that included bailouts, they justified the radical actions by saying they were required to protect us from economic Armageddon.  It is not possible to determine if these policies actually protected us from a more catastrophic meltdown.  However, there are significant consequences to their “free lunch” policies.  We are beginning to see these consequences play out.  People will go hungry.

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Fed Policies Hindering Economy

Posted by Steve Markowitz on June 6, 2013

Since the 2008 financial crisis the Federal Reserve (Fed) and central banks worldwide have been on a grand experiment.  They pushed interest rates to near zero and have been printing money at historic levels, sometimes referred to as Quantitative Easing.  When these efforts were first employed they were justified with the theory that without them the world was heading towards economic Armageddon.  That claim will never be proved, but there is no doubt the financial markets froze up and required action.

We are now five years past the height of the financial crisis and Fed policies remain unchanged.  We also now have the benefit of history that indicates the policies have not cured the economic malady facing United States and much of the world.

David Malpass, an assistant Treasury Secretary during the Reagan Administration, published an op-ed in the Wall Street Journal titled “Fed Policy is a Drag on Recovery” proffering the view that the Fed’s low-interest policies have hindered economic growth and recovery.  Malpass’s op-ed includes (emphasis added):

As this month’s stock and bond market gyrations showed, traders are obsessively focused on every nuance of the Fed’s monetary plans.  Billions of dollars are at stake for Wall Street, which profits mightily from the Fed’s bond buying and cheap credit.”

Recoveries are normally fast and broad once markets are allowed to clear and begin operating.  Quarterly growth topped 9% in 1983 after a deep recession and 7% in 1996 leading into President Clinton’s re-election.  Interest rates were high, yet median incomes were rising sharply.”

Growth in the current recovery only rose above 4% once, in the fourth quarter of 2011, and averaged just 2% per year in its first four years versus 5% in the same period of the 1980s recovery, 3.2% in the 1990s recovery and 2.9% in the 2000s recovery.  The underperformance over the past four years translates into more than three million jobs that should have been created but weren’t, an economic disaster that lowered real median incomes by 5%.”  In addition, “Private-sector credit grew only 0.8% from the end of 2008 through the end of 2012, whereas credit to the government grew 58%.”

Tax-and-spend policies sapped investment, and the Fed’s low rates and bond purchases damaged markets, hurt savers and channeled credit to the government at the expense of job creators.  It’s a zero-sum process that should be stopped because of the bad effect on growth and jobs.”

“Incredibly, as Fed Chairman Ben Bernanke alluded to in his May 22 congressional testimony, the Fed is now angling to create a semi-permanent control dial with which the Fed can increase its $85 billion in monthly bond purchases when growth slows and reduce them if growth ever speeds up.  This creates maximum uncertainty for the private sector, giving an advantage to traders, the government and the rich but hurting growth and long-term investors.

“This trickle-down monetary policy has contributed to very fast growth in corporate profits, part of the explanation for the record stock market, but also to weak GDP growth and declining middle-class incomes.  The extra credit the Fed channeled to government and big corporations meant less credit elsewhere in the economy, a contractionary influence since most new jobs come from small businesses.”

Finally, Malpass quotes retired Federal Reserve Chairman Paul Volcker who recently said that the Fed should not “accommodate misguided fiscal policies” and that such policies “will inevitably fall short.”  Volker also said of the Fed that “credibility is an enormous asset” that ”once earned, it must not be frittered away.”  Given the failure of the Fed’s accommodating policies its credibility has been severely damaged.

President Obama was recently praised by retired Secretary of State Colin Powell for his handling of the economy based on the stock market’s high valuation and the improving unemployment rate.  The lofty stock market valuation in a slow-growing economy is a negative sign of a bubble.  As for the employment rate, the chart below shows that it is now at a 30 year low.  Decades of government intervention, along with the current Administration’s and Fed’s failed policies, are the cause and need to be dismantled.

EMployment History

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Federal Reserve Determined to Create Bubbles

Posted by Steve Markowitz on May 9, 2013

This Blog does not fully agree with the philosophies expressed by Ron Paul.  However, on the subject of the Federal Reserve, he gets it more right than wrong.  Below is one of his recent writings on the mess being created by the Federal Reserve’s near zero interest rate policies.

Paul - Bubbles


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Volatility Index Points to Bubble Creation

Posted by Steve Markowitz on March 12, 2013

VixA useful chart in understanding the mood of investors is the Volatility Index referred to as the VIX.  This Index is the “fear gauge” for equity markets.  The higher the VIX rating the greater the fear.  As indicated by the chart, the fear index is at historic lows.  It is therefore not surprising that equities’ values are the highest they have been since the economic meltdown began over four years ago.

In a “normal” economic environment, high equity valuations generally indicate a positive economy, suggesting strong business fundamentals.  Given the length of the current economic turmoil there is something else at play.  The culprit or benefactor, depending on one’s perspective, is the Federal Reserve and its policy of continuing to keep interest rates artificially low.

With returns on safe investments near zero, investors are looking for increased yields and this is resulting in increasing equity and commodity prices, i.e. more risky investments.  This is a sure sign of bubble creation, precisely what the Fed desires.

With onset of the financial meltdown, the Fed decided to offset the economic downturn by printing money that when circulated increases asset values.  While this led to some positive effects in the short run, when bubbles pop, and they always do, the results are very unpleasant, as we learned with the housing market.

How far has the VIX moved?  As the 2008 financial crisis unfolded this index hit 80.  It is currently at about 12.  Imprudent financial decisions are made by investors when the index is at the fringes.  Supporting this conclusion is JPMorgan’s speculative position indicator that concludes investors are taking on the most risk since the third quarter of 2007, just prior to the meltdown.  In addition, with cheap money availability, investors are increasing the usage of leverage, another problematic tool when bubbles are created.

Potential bubbles are not only showing up in US equities’ markets.  The Fed’s policies have incentivized bubble creation throughout the world including other stock markets and Chinese real estate.  Given the inter-dependence between world markets, a collapse of any of these bubbles is problematic on an international basis.

Some well-respected financial experts are offering warnings on asset inflation and the potential for large market corrections (bubbles bursting).  PIMCO’s Bill Gross, perhaps the most respected bond expert in the world, offers caution stating:

“Yet the common sense of John Law – and likewise that of Ben Bernanke – must have known that only air comes for free and is “essentially costless.”  The future price tag of printing six trillion dollars’ worth of checks comes in the form of inflation and devaluation of currencies either relative to each other, or to commodities in less limitless supply such as oil or gold.  To date, central banks have been willing to accept that cost – nay – have even encouraged it.”

US equity markets have had a great run.  However, such events often convince people that we are in a new economic paradigm and that the market will continue to go up.  While it is possible that there remains upside, downsides are often not seen until it is too late.  Prudent investors would do well to listen to experts like Bill Gross.


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