The Federal Reserve’s tools for achieving its dual mandate
of low inflation and full employment manipulate interest rates and therefore
markets. This manipulation of rates reverberates
globally. Their manipulation historically had been more light handed and
invisible to most of the public. However, over the last decade, their impact on
interest rates and yield levels have been the most dramatic in the history of
the Federal Reserve.
Whenever you have policies that are extreme, it is best to
stay at extremes for the shortest time possible. Newly employed policies always have unknown
and unexplored side effects that can prove to be harmful and detrimental. For instance, pharmaceutical companies have a
long testing period before new products can be offered to the public. But monetary policy works with impunity towards
negative consequences. No accountability
and the subterfuge of finding other scape goats encourage testing these extremes.
During economic downturns, the Federal Reserve experiences
pressure from politicians and the public to act in whatever manner necessary. Pressure to adequately address what are normal
and healthy corrections in long business cycles is smothering and the Federal
Reserve members oblige. But obliging
over the past decade without reverting policy back to normal has created unprecedented
low levels of interest rates and trillions in bonds on the Fed’s balance sheet,
flooding the banking system with an unhealthy amount of funds.
The Federal Reserve has arguably achieved its dual mandate years
ago. The employment situation has been
healthy and healed for years and now is considered historically as tight as
this country has ever experienced. This
will lead to scarcity of labor in certain sectors going forward. Businesses will be confronted with higher
labor costs competing for limited resources or relocating to areas with more
But what about inflation? The Fed’s preferred gauge of inflation seems
to be running at or slightly below their targeted level of 2%. Sounds like they have hit their target even
though they have pursued the most aggressive monetary policy in the worlds
history. Shouldn’t we have runaway
inflation with such easy central bank policies?
Unfortunately, we do.
Inflation is, simply put, out of control. If the Fed took their inflation blinders off
and included asset prices into their inflation statistics, the negative
ramification of their policies would be apparent. Fed policies have led to hyper- inflation and
parabolic moves higher in certain financial asset classes. Inflation in goods and services consumed can
be difficult for the public. But this
type of inflation does not lead to systemic issues putting the economy at risk
of a severe downturn. However, the
financial asset inflation Fed policy has created, but turns a blind eye to, is
dangerous and destructive and can take years to remedy.
One asset class that typically shows Fed induced asset
inflation is in housing. In 2006, easy
Fed policy lead to rapid inflation in this asset class and contributed to the
protracted downturn and systemic issues of 2008 and beyond. Current Fed policy is producing gains in
housing two to three times the rate of preferred Fed calculated inflation. History sure does rhyme if not repeat.
Housing is a more visible asset class that is easy to see asset
inflation – or bubble like conditions – as they happen. Another
asset class that has seen significant asset inflation and bubble lie conditions
are crypto-currencies such as Bitcoin.
Bitcoin has had meteoric appreciation of around 1,500% this year. Fed policy of taking all interest away from
savers for such a protracted period have made alternate stores of value that
also pay no interest a viable alternate currency. Had the Fed not changed the system of fiat
currency that encourages holders by providing a level of interest that is
greater than the loss of purchasing power, such alternate currencies would not
be making headlines. Worse, now that
they have been receiving such media attention, people are investing and using
these currencies without realizing, like the tulip mania, the crypto store of
value may just be a fad with nothing to show once the fad runs its course. At the end of tulip mania, fortunes were
ruined, but the gardens still had pretty flowers to console. I hope a Bitcoin screensaver will console as
well when its store of value disappears.
How many other crypto-currency like bubbles are percolating
under the system? How much asset
inflation have we experienced since the Fed unleashed the easiest monetary
conditions upon us? Questions, that when
answered, will leave many with losses and economic difficulties. Is it worth turning a blind eye to the asset
inflation byproduct of Fed policy because it is not measured in preferred inflation
metrics? Some say ignorance is bliss. Is it?
by Michael Carino, Greenwich Endeavors, 12/7/17
Michael Carino is the CEO of Greenwich Endeavors and has
been a fund manager and owner for more than 20 years. He has positions that benefit from a
normalized bond market and higher yields.