Tag Archives: taper

Why the FED will Increase the Target Rate Before Tapering and the DC Budget/Debt Ceiling Paralysis Matters Not

9/27/2013 Portland, Oregon – Pop in your mints…

Autumn is upon us here in the Northwest.  As in most places, it is a refreshing return to the dance of life that we will live together over the next nine months under the requisite cover of rain and cloud.

If occurrences in nature can be trusted as future economic guidance, we are setting up for a phenomenal year in terms of production.  Salmon runs up the Columbia basin, which were once nearly extinguished altogether, are crushing all previous records this year, and word is that the Tuna catches in terms of quantity are staggering.  Corn yields further east in Minnesota are on pace to increase even on a decrease in acreage planted.

Even the Mushroom pickers are reporting a bumper crop.

Mushroom picking; illustration to III tome "Pan Tadeusz" circa 1860 by Franciszek Kostrzewski
Mushroom picking; illustration to III tome “Pan Tadeusz” circa 1860 by Franciszek Kostrzewski

Nature is doing its part to provide for us on any number of fronts, despite what Malthusian apologists and central planners may say, the only thing holding humankind back are the restrictions that it places upon itself.

Chief among these restrictions is the unnatural monopoly that exists with regards to the production of money and credit, which paradoxically are one in the same in the current “debt is money” scheme under which the entire financial world operates.  For the uninitiated, the monopoly that we speak of is that of the Central Banking institutions, which have been given unchecked authority to manipulate (notice our choice of terminology in place of the more quaint verb “setting” which is normally propagated) short (and now long term) interest rates as well as to determine what serves as legal tender.

Add to these monopolistic practices the ultimate authority to collect taxes and the extent of the monopoly which Central Banks have been granted becomes clear.

Given the existence of this monopoly, it is little wonder that those who make their living by working closely with money and debt, as we do, or those who hold a large amount of money and debt instruments examine the actions of the Central Banks with a great deal of anticipation and scrutiny.

The Central Banks are not to be watched because they have anything special or relevant to offer in the form of clairvoyance or enlightenment, rather, they are to be watched in the same way a pack of dogs must be watched when boarding an airplane, for their movements, while unproductive, tend to bother and in the worst of cases, cause harm to the rest of the passengers.

Against this backdrop, the captive watchers of the Federal Reserve were somewhat surprised this past Thursday that the Central Bank decided to delay their much anticipated “tapering” operation.  The decision to leave the current amount of money printing (Quantitative easing, that is) at current levels, which amount to roughly $115 Billion per month, was welcomed with a certain degree of shock by those who were certain that the program would be discontinued in light of the recent strength in the US economic data reports.

Entitlement: Why the FED will Raise the Target Rate Before Tapering

The decision did not surprise us, however, for the following reason.  The Quantitative easing program has essentially become an entitlement in the sense that it guarantees the credit system a buyer of last resort for the current level of mortgage backed and other securities which the FED purchases from their holders.  Were this program to be dialed back, it is clear which entities would be hurt by the action.  Entitlements of this sort are nearly impossible to take away once they are in place.

On the other hand, the other tool that the FED would theoretically use to signal it was responding to strong economic data by working to tighten credit (something that will not occur within the next three to five years, no matter what the FED does), is by manipulating short term interest rates via the SOMA and POMO.  They are more likely to test the waters by letting rates drift higher as this is an action that does not necessarily have direct consequences for certain market actors.  While some of the consequences are predictable, they are in the end indirect consequences, which give them less the feel of an entitlement, which is what the QE program has become.

In any event, by espousing a policy of giving “Forward Guidance,” which theoretically gives juice to existing policy actions by providing certainty to market participants as to how long certain policies will be in place, the FED is now, monthly, placed in the impossible position of showing the world how much its “word” is worth, as Forward Guidance only works if that guidance is actually reliable.

You see, contrary to what academics such as Michael Woodford, who is credited with originating the Forward Guidance principle, might say, the word of an organization and/or individual, like a debt instrument, can also be discounted based on the prevailing belief as to the extent to which the promises of the individual and/or organization can be trusted.

While the actions of the Federal Reserve, whatever they may be, are for some reason seen as immediately effective is beyond us.  In our models it is clear that any action taken by the FED with regards to interest rates does not significantly impact price and wage levels outside of the financial sphere for three to five years.  Nevertheless, the Federal Reserve actions are observed by algorithms which “think” differently than we do, and it is these algorithms which drive large scale equity trading circa 2013.

Fiscal Policy vs Price Levels:  Why the DC Budget/Debt Ceiling Paralysis Matter Not

Perhaps even more ineffective and innocuous to the economy in the short term than Federal Reserve action are the actions that are taken (or not taken) by the Federal Government.

The news is currently ablaze with the current scenario in Congress which has managed to entangle the Federal Budget, the Debt Ceiling, and Obamacare in the same line of debate.  This type of stalemate in terms of budget matters is absolutely normal and to be expected of technically bankrupt entities.

The past three years, which have seen at least two other debates around the debt ceiling as well as various sequesters, furloughs, disastrous tax and fiscal policy, and arguably a complete failure of any inkling of “Forward Guidance” out of the Federal Government, have taught the economic community one very important lesson:

Despite members of each party assuring the public that the outcome of these debates and any failure to act will destroy the economy, whether these debates are resolved or not is of little consequence.  The reason that they are inconsequential is that the major actors in the US economy, which are and always will be at least one step ahead of both politicians and central bankers, have already discounted the true impact and likelihood of government action by tacitly adjusting their activities to adapt to the inherent uncertainty.

So relax, the no matter what the FED or Congress do or fail to do, the risks remain firmly on the upside for at least three to five more years or the day that the current “debt is money” system fails, whatever comes first.

Stay tuned and Trust Jesus!

Stay Fresh!

David Mint

Email: davidminteconomics@gmail.com

Key Indicators for September 27, 2013

Copper Price per Lb: $3.29
Oil Price per Barrel:  $102.77
Corn Price per Bushel:  $4.54
10 Yr US Treasury Bond:  2.62%
Mt Gox Bitcoin price in US:  $140.00
FED Target Rate:  0.08%  ON AUTOPILOT, THE FED IS DEAD!
Gold Price Per Ounce:  $1,337
MINT Perceived Target Rate*:  0.25%

August and Everything After All Over Again

9/23/2013 Portland, Oregon – Pop in your mints…

Most persons in the financial industry, and likely beyond may recall that a mere five years ago, the Lehman Brother’s bankruptcy filing rocked the financial markets and served as the official notice that the blind 25 basis point hikes in the FED target rate that had passed as “monetary policy” during the go-go years of the early 2000’s were not exactly what the economy ordered.

In a matter of months, an entire industry that had been operating in a nearly infallible uptrend since the early 1970’s began to retool itself to cope with significant downside risk.

The Lehman event took place on September 15th and, while it did not exactly catch the US Treasury and the FED off guard, it did catch them without the resources or authority to do anything about it.  As Phillip Swagel details in this piece “Why Lehman Wasn’t Rescued,”:

“Lehman failed before TARP was passed or even proposed to the Congress. This meant that the Treasury Department had no legal authority to put government money into the firm or provide a guarantee for its obligations. This changed with the passage of the Emergency Economic Stabilization Bill on Oct. 3, 2008, which provided $700 billion in TARP financing to be used to purchase troubled assets (used in the end mostly to purchase preferred shares in banks).”

Swagel goes on to state that the cases of both Bear Stearns and AIG, whose subsequent bailouts caused Lehman stakeholders, amongst others, to cry foul, differed on one very significant count:

“To all eyes, the problem at Lehman was one of solvency while the issue in the other two cases was liquidity. The Fed’s actions on Bear and A.I.G. were thus appropriate in its role as a lender of last resort and the same with its caution at Lehman.”

And so began the cascade of minifailures which have become collectively known as the Financial Crisis of 2008, as liquidity was provided to the solvent while the insolvent went quickly into history’s dustbin.

At The Mint, we refer to this odd period of time as “August and Everything After,” with apologies to the Counting Crows.  It was a time when the industry threw in the towel, and the prevailing current became one of loss avoidance.

Today, just over 5 years later, we believe that we are at a similar inflection point with regards to tendencies in the financial markets, hence our tagline “August and Everything After All Over Again,” only this time, the tremendous risks in the financial system are not on the downside, where everyone is looking for them, they are on the upside, where few dare to tread.

The few who have tread confidently on the upside risks, despite the commonly held beliefs to the contrary, would have nearly tripled their money by doing something as mindless as going long the Dow circa March 2009, when it appeared the Dow companies themselves were to be swallowed up.

At this point in time, the upside risks are hidden from most.  While the stock market continues to churn out an impressive performance, a more significant trend has been playing out in plain sight:  Private investment activity is going through the roof.

While publicly traded equities get nearly all of the airtime, it is becoming clear that the advantages of being a publicly traded company are being outweighed by the regulatory burden and incredible scrutiny that public companies are under.  To sum up the plight of public companies circa 2013, they are easy targets.

The answer for many has been to “go private,” and go private they have, from Ford to Blackberry, companies that once basked in the public limelight have found that going private may be just what the doctor ordered.

To accentuate this trend, today is the day that a key provision of the JOBS act takes effect, allowing private companies and startups to solicit accredited investors publicly rather than needlessly lurking about in the shadows as they had done since the days of the Great Depression.

The Role of the Federal Reserve

The Federal Reserve, in direct violation of Natural Law
The Federal Reserve, in direct violation of Natural Law

FED observers watched in near disbelief last week as the US Central Bank declined to “Taper,” which means to scale back the amount of money that they simply print and hand to holders of US Treasuries and Mortgage Backed Securities, citing downside risks.

In observing the FED, we can confirm that the economy currently faces unimaginable upside risks, as they are paradoxically always the last to react to market realities which they have unwittiningly created.

The FED and their observers labor under a belief that is both accurate and woefully misguided all at once.  It is true that the Federal Reserve, in regulating short term interest rates and the base money supply, has nearly unchecked influence on the level of economic activity anywhere that dollars are used in exchange.  This is a simple reality of the insane “debt is money” monetary system that the world suffers under.  The primary issuer of the debt determines how much money there is.

They are wrong in thinking that the FED is clairvoyant in any sense of the word and can somehow time their interventions to achieve desired effects on the underlying economy.  In this sense, the FED is always the last to react as it has no idea what the true timing of the cause and effect of their policy decisions are.  While they have produced reams of academic work to prove their theories, in practice, it is nothing more than guesswork with the benefit of hindsight.

This is also why the FED will only “taper” when nobody cares whether or not they taper, i.e. when there is so much money flooding the system that the dangers are clearly on the side of hyperinflation.  Inflation, in their mind, is much easier to fight than the deflationary spiral the the Lehman event triggered five short years ago.

They are right in the sense that in a hyperinflationary environment, the monetary system simply needs less juice, where a deflationary environment threatens their stranglehold on the world’s monetary system.

To understand the depth of the incompetence of the FED and Central Bankers at large, one need only look to their latest hero, Michael Woodford.  Mr. Woodford wrote a book titled “Interest and Prices:  Foundations of a Theory of Monetary Policy” in which he deals with problems of zero bound rates and quantitative easing, ideas that were being toyed with back in 2003 when the book was published as mere theory.  Now, they are part of a Central Banker’s everyday life, and Woodford’s book is considered their bible.

The base of Woodford’s theory, which we have come to know as “foreword guidance,” is that when monetary policy is accommodating maximum liquidity and the system still lacks it, policy makers must resort to telling market participants what they will do, essentially tying their hands in the future, in order for liquidity to exceed its theoretical limits.  This is the only reason why Ben Bernanke now holds a press conference after FED policy meetings, so that this theory can be implemented.

Woodford’s theory of Foreword Guidance, like Quantitative easing, is further evidence that the current monetary system has failed.  It has failed in the sense that even unlimited amounts of debt masquerading as money cannot satiate the need for liquidity in global markets, which are so disconnected from actual physical conditions that it is impossible to tell which projects are a net benefit to humankind and which take humankind further down the path to fantasyland, where all play and no work promises a lot of pain and scarcity down the line.

The risk in the “After August” period is to the upside, and central bank notes will become irrelevant as the global economy goes into overdrive and a new monetary system will be tacitly agreed upon by all participants.

When the Central Bankers of the world look up from Woodford’s textbook, they may catch a glimpse as the Tsunami of liquidity washes their currencies away.

The FED has nearly doubled the base money since 2008, are re you ready for it to multiply?

Stay tuned and Trust Jesus!

Stay Fresh!

David Mint

Email: davidminteconomics@gmail.com

Key Indicators for September 23, 2013

Copper Price per Lb: $3.27
Oil Price per Barrel:  $103.40
Corn Price per Bushel:  $4.53
10 Yr US Treasury Bond:  2.71%
Mt Gox Bitcoin price in US:  $133.43
FED Target Rate:  0.09%  ON AUTOPILOT, THE FED IS DEAD!
Gold Price Per Ounce:  $1,322
MINT Perceived Target Rate*:  0.25%
Unemployment Rate:  7.3%
Inflation Rate (CPI):  0.1%
Dow Jones Industrial Average:  15,401
M1 Monetary Base:  $2,469,100,000,000
M2 Monetary Base:  $10,783,000,000,000