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.
Posted in Federal Reserve, Interest Rates | Tagged: Bailouts, Bubbles, Currency, Fed, Inflation, Interest Rates, Interventions, monetary, Policies, US | Leave a Comment »
Posted by Steve Markowitz on October 6, 2011
Since the dotcom meltdown over a decade ago, the Federal Reserve has pursued a low-interest policy as the elixir for all economic downturns. This is medicine was also used after the 9/11 attacks and more recently on steroids after the financial meltdown of 2008. Interest rates have remained near zero for a significant portion of this period.
While the low-interest rate policy initially forestalled economic slowdowns for extended periods, it has not done much to cure the ongoing financial downturn that started in 2008. In fact, these low interest rate policies likely led to bubbles, including the housing bubble, which ultimately helped create the 2008 meltdown.
Besides questionable benefits and bubbles caused by the Fed’s low interest rate policies, there are other consequences. One is the financial damage done to people on fixed incomes, particularly retirees, whose incomes have significantly decreased with the interest rates on their savings accounts. These low interest rates have promoted more aggressive investment behavior for these people that may further damage them going forward.
Another looming problem from the Fed’s low-interest rates involves America’s life-insurance companies. Certain life insurance policies include guaranteed return rates for policyholders. When determining these rates, life insurance companies assume rational behavior by government and Fed relating to interest rate policies. Such has not been the case with the near zero rate policy in place already for three years with the Fed indicating they will remain there for another two.
In attempting to determine what effect the low-interest rates will have on American insurance companies we can look to Japan. Japan has been in a recession caused by the bursting of their real estate bubble for nearly 20 years. Their central bank has used a similar low-interest rate policy that continues to this day. According to the Wall Street Journal, halfway into their recession, about a decade ago, some of Japan’s major life-insurance companies failed. Unfortunately, we can expect the similar results in United States if the Fed continues on the current path.
The axiom that there is no such thing as a free lunch is always true when it comes to economics. There will be consequences to the Federal Reserve’s protracted use of low interest rates. Should these impact life insurance companies to the point of threatening their solvency, we will then be faced with yet another huge bailout demand. This viscous cycle will need to be broken. It’s only a matter of time when a future bailout will be too large for the government to handle.
Posted in Bailouts, Interest Rates | Tagged: Bailouts, Bubbles, Fed, Federal Reserve, Interest Rates, Japan, Life Insurance | Leave a Comment »
Posted by Steve Markowitz on September 23, 2011
Yesterday this Blog posted a piece reviewing the downside of the super low interest rate policies implemented by the Fed (Federal Reserve). This included challenges caused to companies, states and municipalities that have Defined Benefit pension plans. Today, the Wall Street Journal posted an article estimating the costs of the problem.
Defined Benefit pension plans determine how much funds their providers must put in each year via complex formulas that include historically received return rates and the returns on 30-year U.S. Treasury bond. We currently have a perfect storm brewing with the S&P 500 down more than 10% this year and the 30-year Treasuries yielding about 2.8%, an historic low. To make matters worse, private pension funds continue using unrealistic return projections of about 8%. Impossible!
The Journal reported Credit Suisse’s estimates that in August, S&P 500 companies with these pensions have a deficit of about $388 billion, up from about $200 billion since the New Year. With downward market moves since, the deficit is now likely about $450 billion. Affected companies include some of the remaining large US manufacturers like Goodyear Tire, AK Steel, Lockheed Martin and Northrop Grumman. Credit Suisse estimates that that the declines in their pension funds valuations/returns equal a staggering 10% of their market cap. Yikes!
The Fed and governments have taken a short-sighted view of the economy. They stimulated, bailed out and offered cheap money to kick the can down the road. As the looming pension problems show, there are consequences to these bad policies. Pensioners, the government’s pension insurance, and manufacturers that still offer Defined Benefits pension plans will pay a heavy bill for these ill-advised policies.
Posted in Federal Reserve, Interest Rates | Tagged: AK Steel, Credit Suisse, Defined Benefit Plan, Fed, Federal Reserve, Goodyear Tire, Lockheed Martin, Northrop Grumman, Pension, Treasury Bonds | Leave a Comment »
Posted by Steve Markowitz on July 13, 2011
MSNBC reported on today’s comments by Federal Reserve Chairman Ben Bernanke that indicate the Fed is prepared to double down on failed policies. Since the 2008economic meltdown, the Fed has instituted a low interest rate policy that also included two-rounds Quantitative Easing (QE). It is evident from Bernanke’s rather native comments and the persistently high unemployment rate that these policies have failed. Bernanke said: “The possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support.” This certainly sounds like a warning shot of things to come from the Fed.
Bernanke offered three options for the Fed:
- Start a third round of QE (U.S. Treasuries buying), even though he indicated in the past that the Fed would not to repeat this action.
- Cut the interest paid banks on reserves held.
- Threaten to announce long-term plans to keep interest rates at historic lows
Only in government and academia can failed policies be rehashed and reused with little question as to why. Albert Einstein defined iinsanity as doing the same thing over and over again and expecting different results. While Bernanke’s intelligence is hard to question, one cannot say the same for his sanity.
Posted in Federal Reserve, Interest Rates | Tagged: Ben Bernanke, Fed, Federal Reserve, QE, quantitative easing | Leave a Comment »
Posted by Steve Markowitz on June 8, 2011
Federal Reserve Chairman Ben Bernanke yesterday spoke at the American Bankers Association gathering in Atlanta, Georgia. His message was not comforting with the Dow Jones Industrial Average dropping 40 points in the past two days.
Bernanke’s view of the economy was viewed as glum by some, even though the Fed chairman predicted improvement later this year. Unfortunately, Bernanke’s track record on predicting the economic future has not been impressive.
In his speech the Fed chairman said:
“The U.S. economy is recovering from both the worst financial crisis and the most severe housing bust since the Great Depression, and it faces additional headwinds ranging from the effects of the Japanese disaster to global pressures in commodity markets. In this context, monetary policy cannot be a panacea.” Bernanke continued that the recovery is “continuing at a moderate pace, albeit at a rate that is both uneven across sectors and frustratingly slow from the perspective of millions of unemployed and underemployed workers“.
Those words raised some eyebrows. Blaming disasters such as occurred is Japan is lame since unplanned natural events or even manmade ones continuously occur. Also, blaming the rise in commodity prices on the economic malaise was curious since much of the increase is the result of the Fed’s own easy money policies. Finally, admitting that monetary policy cannot be a panacea begs the question as to why the Fed implemented such radical monetary policies in the first place.
Possibly the most significant message from Bernanke was an indication that the Fed will stop printing money later this month; in other words no QE3 (Quantities Easing). This has the potential to cause significant changes in the bond markets.
Through Quantitative Easing, the Fed in essence prints money (U.S. dollars) and then uses the dollars to purchase Treasury bonds; i.e. U.S. debt. Sounds like a free lunch? Well it is not. Sooner or later its costs include inflation, such as we are already seeing in worldwide commodity prices.
The amount of Quantitative Easing has been huge. For QE2 that ends this month, the Fed purchased $600 billion in U.S. Treasury bonds, an estimated 85% of Treasury’s sold in that eight month period. What happens when the Fed stops buying the bonds? The answer is it depends. Should foreign buyers not have an appetite for the additional Treasuries available, interest rates on them will increase to attract buyers leading to higher cost for America’s barrowing. That will increase the U.S. deficit and lead to higher consumer credit rates since they must compete with Treasury rates. With the United States requiring about $1.4 trillion of additional barrowing this year, this is a potentially serious issue.
It is at best difficult to predict how one event, such as the Fed pulling out of the Treasury bond market, will affect interest rates in a complex financial world. One sign that points to the likelihood of higher interest rates is the actions of Bill Gross, head of Pimco bond fund, the largest bond buyer in the world. Pimco recently reduced its holdings of U.S. Treasuries to zero. That’s a significant vote with a great deal of assets. Following Bill Gross is usually not a bad strategy.
The Federal Reserve initiated Quantitative Easing to prime the financial pump. They successfully drove down long-term interest rates with 30-year fixed mortgage going down to nearly 4%. However, this radical action did little to stimulate real economic growth. It is possible that the Fed’s market intervention and pending withdrawing may actually drive rates higher. That will have a contractive effect on the overall economy.
It is likely history will view the Fed’s Quantitative Easing program a dismal failure. However, as long the folks running the Fed are the ones that decided to proceed with the intervention, do not expect them to admit error. As for the President and Congress, they will most likely continue like Lemmings following Bernanke over the cliff.
Posted in Federal Reserve, Interest Rates | Tagged: Atlanta, Ben Bernanke, Bill Gross, Deficits, Fed, Federal Reserve, Inflation, Interest Rates, Pimco, QE, quantitative easing, Treasury Bonds | Leave a Comment »
Posted by Steve Markowitz on May 27, 2011
There are always consequences to governmental meddling in the economy. In 1996, the Federal Communications Commission came out with the Telecom Reform Act that helped cause the telecom bubble and bust. Adding fuel to this fire, the Federal Reserve flooded markets with liquidity to avoid the supposed Y2K disaster, which was a fraud created by the IT industry. Tens of billions were lost by investors in companies whose names have since long been forgotten
To combat the negative economic effects of 9/11, the Fed pushed interest rates artificially low and kept them there for too long. This action and Congress imposing rules on Fannie Mae and Freddie Mac forcing them to offer mortgages to those that could not afford them, resulted in the even larger housing bubble and bust that led to the financial meltdown of 2008.
Since 2008, the government and Fed have doubled down on the last bad bet, again pushing interest rates even lower and bailing out all sorts of folks (and companies) that made bad choices. This has caused economic distortions, some of which are easily visible. For example, bailed out banks are now making record profits, but also making no loans. In addition, increased prices of commodities are causing inflation. Now, once again high-priced (overpriced) IPO’s are in style.
Andy Kessler, a former hedge-fund manager, wrote an op-ed in today’s Wall Street Journal that points to recent IPO’s (Initial Public Offerings) valuations that are overpriced.
- LinkedIn, a Professional network company had IPO initially valued at $45 per share. It ended at $94 on the first day, giving the company an equity value of $9 billion, 30 times sales and 666 times earnings. Historically, even very good growth companies have not been valued at more than ten times earnings.
- Yandex, the Russian version of Google, just started trading and is now worth $10 billion.
- Facebook currently has $70 billion valuation.
- The overall stock market is within 15% of its all-time high. This valuation seems dubious given the economy’s overall condition.
The Fed’s low interest rate policy is not the result of the supply and demand for funds. Instead they are artificially set at historically low rates in an effort to create wealth where it does not exist. This is nothing more than economic alchemy,
What will be the consequences be of the distortions caused by the government’s economic meddling since the 2008 meltdown? That is yet to play out. However, it is clear there will be consequences and if history is an accurate fortune teller, they will not be pretty. One outcome is clear: the markets will ultimately properly value the recently introduced IPOs.
Posted in Federal Reserve, Interest Rates | Tagged: Bailouts, Bubbles, Facebook, Fannie Mae, Fed, Federal Reserve, Freddie Mac, Interest Rates, IPO, LinkedIn, Stock Market, Telecom Reform Act, Y2K, Yandex | Leave a Comment »
Posted by Steve Markowitz on April 17, 2011
The Wall Street Journal reported on Friday the following:
Ireland – Moody’s cut Ireland’s bond ratings to Baa, nearly “junk” status. This will add pressure on Ireland’s debt making in more expensive for Ireland to sell bonds.
United States – The consumer-price index rose a seasonally adjusted 0.5% in March with gasoline increasing 5.6% and groceries increased by 1.1% for the month. These figures indicate that inflation is rising in the U.S., something everyone seems to get outside of the Obama Administration and Federal Reserve.
China – Its consumer price index increased in March 5.4% from 2010. That shows inflation is accelerating in China. The Chinese government has aggressively been increasing interest rates in an attempt to halt the inflation.
These data points from three countries in very different parts of the world indicate that interest rates in the United States, including those for U.S. Treasury bonds, will be increasing in the foreseeable future. While this will slow the U.S. economy, the larger problem with the increasing rates is their affect on the U.S. debt. The increased rates will raise the cost for the U.S. to pay for the huge debt already incurred, which will then leave less funds available for the government to pay for programs and its everyday bills. Should the politicians in Washington not get control of our spending and soon, the bond market will inject that discipline in a much more painful manner via higher interest rates.
Posted in Inflation, Interest Rates | Tagged: Bonds, China, Inflation, Interest Rates, Ireland, UNited States, US Treasuries | 2 Comments »