from TheWealthWatchman:
Who’s Going To Eat The Losses?
The only question that matters regarding today’s markets
by Chris Martenson, Peak Prosperity:
Unsustainable.
Many more people need to understand what that word really means, and how it applies to pretty much everything in the current human living arrangement. Especially the so-called ‘developed’ nations.
Here’s the dictionary definition:
Let’s take these three definitions one at a time.
First: our entire economic model, which dependent on borrowing at a faster rate than income (GDP) grows, is something that simply cannot be maintained at its current rate or level. Check.
Second: depleting species, soils and aquifers are all wildly unsustainable practices that are accelerating. Check.
Last (and most glaring of all): the world’s leadership (and we use that term very loosely) continues to insist on adhering to the indefensible idea that infinite growth on a finite planet is possibleCheckmate.
Said another way, the daily comforting stories we are told about how all of this somehow makes sense are just a load of nonsense. Each is entirely unsupportable by the evidence, facts and data.
What happens when a culture’s dominant narratives are not just unsatisfactory, but entirely unworkable?
Well, for one thing, the younger generations that are being asked (goaded?) to step into an increasingly flawed future begin to resist. Which is completely understandable. They have nothing to gain if the status quo continues.
At the same time, the older generations mostly just settle into a stubborn insistence that everything will be fine if everyone will just do more of precisely what got us into the mess in the first place. Younger people should step up to make sure Medicare/Social Security/pensions remain fully funded, and buy the financial assets and homes of downsizing seniors at top dollar. The boomers have everything to lose if the status quo changes.
Why do I bother to tell you all this? Why have I spent the last ten years of my life trying to alert the public of risks they keep telling me make them uncomfortable? Because I care. Because I hope to help a few people preserve their hard-earned wealth. Possibly even save a few lives with this information. And, ultimately, to help people lead lives filled with greater connection, aliveness and joy.
The key to all of these better outcomes is having a clear-eyed view of “what is”, and then being able to predict “what’s next”. Which means that understanding is the first step. Informed action follows from that.
Mind The Gap
In the US, through selfish over-consumption, the baby boomer generation has screwed the prospects for following generations. It’s now doing everything to deny and defend its extraordinarily self-serving and short-sighted decisions, and delay the repercussions for as long as possible.
For the record, I seriously doubt the current younger generations would have behaved any differently were we to teleport them back in timeThe boomers came of age when net energy from oil was still climbing and that ‘taught’ them about ‘how the world worked.’ When you have abundant resources, especially high net energy oil, you can pretty much do anything you want.
But today?
Not so much. A BIG fallacy of the past is that wars lead to rapid economic expansion afterwards. A more correct version of this is that the destruction of war leads to rapid recovery and rebuilding ONLY IF you also have access to abundant high net energy oil. If you don’t, wars only lead to destroyed economies.
Think of it this way: an 18-year-old who injures his knee has the resources of youth to help them recover completely. But an 80-year-old? Not so much.
This fallacy of thinking that we can just have another nice major war (North Korea?), or a few major hurricanes (Harvey, Irma and counting…), and then not only recover, but return better than ever is a dangerous delusion to hold. It’s no different than our 80-year-old thinking that taking up downhill skateboarding would be a safe and sensible thing to do.
Self-deception is a process of denying or rationalizing away the relevance, significance, or importance of opposing evidence and logical argument. Self-deception involves convincing oneself of a truth (or lack of truth) so that one does not reveal any self-knowledge of the deception.
(Source)
The inter-generational resentment mentioned above is growing ever more extreme and it’s creating a significant social (and soon political) disturbance that will prove to be utterly disappointing for all. Already we see the signs in failing pensions having to cut benefits, young people opting out of such bulwarks of cultural stability as car ownership, marriage and having children.
If the DNC hadn’t straight up stolen the primary from Bernie Sanders, it’s quite possible that he’d have handily won the US presidential election and we’d already be feeling the effects of the political power of the next generation.
In this view, Trump is nothing more than the first (but not final) reflection of boomer denial backfiring badly. The sclerotic remnants of the past held fast and tried to jam Hillary down the throats of a very unenthusiastic electorate that long ago concluded that business-as-usual is literally a vision without a future. And so Hillary was rejected and Trump, the only alternative left standing, got the victory.
Reality of the Dollar
by Martin Armstrong, Armstrong Economics:
QUESTION: Hello Mr Armstrong.
I understand the logic of the weakness / strength of currency that you outline from time to time in your modelling of the global crisis.
You omit to explain the importance in the pace of change in the value of a currency; for instance Venezuela and Argentina according to your explanation of the dollar weakness ought to have benefited from a free falling currency. They are both exporters of natural resources that receive foreign exchange for their exports. Can you please elaborate on this difference? The US dollar is of course not free-falling, but for the global reserve currency, it has fallen precipitously year to date.
My second question concerns the groundhog mentality of a lot of commentators about the dollar and its safe haven status. I wonder why it is that when a group of large countries decide to exclude the dollar from their transactions, it would have nothing to do with that currency’s weakness?
You say the US is an oil exporter; well it does export oil, and it also imports oil of the a different grade to the one it exports. In addition, is it just a coincidence that countless countries with oil assets have been invaded and/or sanctioned in the last 70 years? Persia, Iraq, Libya to name but a handful of energy nations, and let’s also throw in the case of the opium trade coming out of Afghanistan and which has the fingerprints of the US all over it.
I would appreciate not hearing an explanation about the need to spread democracy, human rights and being the honest broker as the reason the US holds 800 bases around the world and is currently the process of agitating to cause harm to the middle east, eastern europe and the south china seas.
Many thanks for your voluntary service to readers, especially the historic aspect of your memos, which are quite fascinating.
Best regards
CAL from Switzerland
ANSWER: Your proposition that the “pace of change” in the value of a currency when it collapses in such places as Venezuela and Argentina ought to have benefited from a free falling currency, is an interesting question that truly reveals the importance of CONFIDENCE. True, Trump and his predecessors since Ronald Reagan have preferred a weaker currency to stimulate foreign sales and thus the theory is such a policy will increase jobs. This is seriously flawed as always because of this one-dimensional analysis attempt to always reduce everything to a single cause and effect.
The value of a currency at its base is constructed upon CONFIDENCE in the government. If you do not TRUST the government, you simply will not accept their currency. This has been the case throughout history. I have pointed out how the Emperor of Japan lost the CONFIDENCE of the people and as such they would no longer accept his coinage. Japan stopped issuing coins for nearly 600 years because each emperor devalued the outstanding coinage to be 10{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} of his new coins. Thus, people would not accept Japanese coins for they could become worthless on the whim of an emperor. They reverted to bags of rice and Chinese coins – not Japanese.
Therefore, a weak currency will stimulate foreign sales provided you TRUST the government. Lacking that, the currency simply goes into a free fall and becomes worthless. This was the fate of the hyperinflation in Germany. It was NOT the Quantity of Money theory, it was the fact that there was a 1918 Communist Revolution in Germany where they had even asked the Communist Russians to take over Germany. It was the collapse in CONFIDENCE that led to the hyperinflation. We saw the same thing in every instance of hyperinflation for that is the free-fall when people not longer trust government. It has never been the Quantity of Money and this is also why the Quantitative Easingpolicy of the ECB has failed.
Likewise, you will see the same impact in interest rates, which are the reflection of future inflation. Rising interest rates will attract capital inflows but only to a point where CONFIDENCE is maintained. If CONFIDENCE in government collapses, then interest rates soar reflecting the risk factor in the Survivability of government.
Consequently, all of these theories are not linear. They operate on a BELL CURVE. It is like my mother always said – too much of a good thing can be bad. A cookie or ice cream may taste great. But you cannot eat only cookies and ice cream. There is a limit to all things before the BELL CURVE comes into play.
Read More @ ArmstrongEconomics.com
Looks Like The COT Report Wins Again, As Gold And Silver Fall Sharply
by John Rubino, Dollar Collapse:
Eventually physical demand for precious metals will swamp the games being played in the paper (i.e., futures contract) markets. So every time the commitment of traders report (COT), which tracks those paper games, turns bearish while gold and silver continue to rise, the precious metals community watches hopefully for signs that fundamentals are at long last about to ignite a massive bull run.
The past couple of months followed this script (see Lightening-Fast COT Reversal: Now Fairly Bearish For Gold And Silver) as gold and silver kept rising for a while in the face of growing resistance in the paper market.
Here’s a more detailed explanation from Hebba Investments via Seeking Alpha:
The latest Commitment of Traders (COT) report, showed another rise in speculative longs for the EIGHTH straight
week. This two-month streak with the net speculative position of gold traders rising every week, has just tied the record-longest gains streak achieved – in the history of the COT report (going back to 2006) it has never risen for NINE consecutive weeks. History for COT nerds (like myself) could be made next week if gold speculators continue their torrid streak.About the COT Report
The COT report is issued by the CFTC every Friday, to provide market participants a breakdown of each Tuesday’s open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.
Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow the small investors a way to see what larger traders are doing and to possibly position their positions accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts – so you may want to take a long position.
There are many ways to read the COT report, and there are many analysts that focus specifically on this report (we are not one of them) so we won’t claim to be the exports on it. What we focus on in this report is the “Managed Money” positions and total open interest as it gives us an idea of how much interest there is in the gold market and how the short-term players are positioned.
Moving on, the net position of all gold traders can be seen below:
Source: GoldChartsRUS
The red-line represents the net speculative gold positions of money managers (the biggest category of speculative trader), and as investors can see, we saw the net position of speculative traders increase by 18,000 contracts to 250,000 net speculative long contracts. We are now approaching some of the all-time highs in gross and net speculative positions – so gold investors need to be wary.
As for silver, the action week’s action looked like the following:
Source: GoldChartsRUS
The red line which represents the net speculative positions of money managers showed an increase in the net-long silver speculator position as their total net position increased by around 10,000 contracts from a net speculative short position to a net long position of 62,000. Silver speculators are a bit further away from their all-time highs than gold speculators, but are still moving up strongly.
We have been Extremely Bearish the last few week and have been dead wrong in our short-term call. When that happens, you have to re-evaluate your call and make sure that the logic is still valid to the situation.
Our bearish thesis was primarily based on the fact that speculative positions are extremely bullish levels, while physical demand remains at some of the lowest levels seen in the last few years. Additionally, the Federal Reserve seems to be tightening monetary policy, while some of the risk-on events (North Korea, US Debt Ceiling, etc.) seem to be calming down. None of this has changed.
Read More @ DollarCollapse.com
Who’s Going To Eat The Losses?
by Chris Martenson, Peak Prosperity:
Unsustainable.
Many more people need to understand what that word really means, and how it applies to pretty much everything in the current human living arrangement. Especially the so-called ‘developed’ nations.
Here’s the dictionary definition:
Let’s take these three definitions one at a time.
First: our entire economic model, which dependent on borrowing at a faster rate than income (GDP) grows, is something that simply cannot be maintained at its current rate or level. Check.
Second: depleting species, soils and aquifers are all wildly unsustainable practices that are accelerating. Check.
Last (and most glaring of all): the world’s leadership (and we use that term very loosely) continues to insist on adhering to the indefensible idea that infinite growth on a finite planet is possibleCheckmate.
Said another way, the daily comforting stories we are told about how all of this somehow makes sense are just a load of nonsense. Each is entirely unsupportable by the evidence, facts and data.
What happens when a culture’s dominant narratives are not just unsatisfactory, but entirely unworkable?
Well, for one thing, the younger generations that are being asked (goaded?) to step into an increasingly flawed future begin to resist. Which is completely understandable. They have nothing to gain if the status quo continues.
At the same time, the older generations mostly just settle into a stubborn insistence that everything will be fine if everyone will just do more of precisely what got us into the mess in the first place. Younger people should step up to make sure Medicare/Social Security/pensions remain fully funded, and buy the financial assets and homes of downsizing seniors at top dollar. The boomers have everything to lose if the status quo changes.
Why do I bother to tell you all this? Why have I spent the last ten years of my life trying to alert the public of risks they keep telling me make them uncomfortable? Because I care. Because I hope to help a few people preserve their hard-earned wealth. Possibly even save a few lives with this information. And, ultimately, to help people lead lives filled with greater connection, aliveness and joy.
The key to all of these better outcomes is having a clear-eyed view of “what is”, and then being able to predict “what’s next”. Which means that understanding is the first step. Informed action follows from that.
Mind The Gap
In the US, through selfish over-consumption, the baby boomer generation has screwed the prospects for following generations. It’s now doing everything to deny and defend its extraordinarily self-serving and short-sighted decisions, and delay the repercussions for as long as possible.
For the record, I seriously doubt the current younger generations would have behaved any differently were we to teleport them back in timeThe boomers came of age when net energy from oil was still climbing and that ‘taught’ them about ‘how the world worked.’ When you have abundant resources, especially high net energy oil, you can pretty much do anything you want.
But today?
Not so much. A BIG fallacy of the past is that wars lead to rapid economic expansion afterwards. A more correct version of this is that the destruction of war leads to rapid recovery and rebuilding ONLY IF you also have access to abundant high net energy oil. If you don’t, wars only lead to destroyed economies.
Think of it this way: an 18-year-old who injures his knee has the resources of youth to help them recover completely. But an 80-year-old? Not so much.
This fallacy of thinking that we can just have another nice major war (North Korea?), or a few major hurricanes (Harvey, Irma and counting…), and then not only recover, but return better than ever is a dangerous delusion to hold. It’s no different than our 80-year-old thinking that taking up downhill skateboarding would be a safe and sensible thing to do.
Self-deception is a process of denying or rationalizing away the relevance, significance, or importance of opposing evidence and logical argument. Self-deception involves convincing oneself of a truth (or lack of truth) so that one does not reveal any self-knowledge of the deception.
(Source)
The inter-generational resentment mentioned above is growing ever more extreme and it’s creating a significant social (and soon political) disturbance that will prove to be utterly disappointing for all. Already we see the signs in failing pensions having to cut benefits, young people opting out of such bulwarks of cultural stability as car ownership, marriage and having children.
If the DNC hadn’t straight up stolen the primary from Bernie Sanders, it’s quite possible that he’d have handily won the US presidential election and we’d already be feeling the effects of the political power of the next generation.
In this view, Trump is nothing more than the first (but not final) reflection of boomer denial backfiring badly. The sclerotic remnants of the past held fast and tried to jam Hillary down the throats of a very unenthusiastic electorate that long ago concluded that business-as-usual is literally a vision without a future. And so Hillary was rejected and Trump, the only alternative left standing, got the victory.
Who’s Going To Eat The Losses?
The US economic data to back up this decidedly dim view of things could not possibly be more robust and unassailable.
If we were allowed just one chart, just a single piece of data to back up this assertion, it would be this one:
The oft-cited and worried over ‘US federal debt’ of some $20 trillion is the lowest dark-blue shaded area on that chart .It’s not even 10{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} of the predicament the country faces
No country has ever dug out from under a debt + liability load anywhere close to that amount. It’s just too big a hole to climb out of.
With GDP growth stubbornly anemic for going on 12 years now, and no fresh sources of high net energy to fund future GDP growth, we can say this very simply about the promises our politicians are soothingly singing to us:
Any thought that these promises will be kept is delusional.
Read More @ PeakProsperity.com
America’s Fiscal Doomsday Machine
by David Stockman, DailyReckoning:
Maybe the Democrats did win the 2016 election. Or at least the the Deep State and its accomplices among the beltway political class, K-Street lobbies and the media did.
That’s because the media won a giant victory against something they deplore and despise more than anything else — the public debt ceiling. They sanctimoniously admonish that it’s a relic of the nation’s fiscally benighted past. They operate on a belief that this is an episodic tendency to threaten America’s credit and to offer Capitol Hill an opening to grandstand about the fiscal verities is a blight on orderly governance.
So the Donald’s latest burst of impetuosity — agreeing with Sen. Schumer to permanently abolish the public debt ceiling — has descended on the beltway like manna from heaven. Not Barack Obama, Bill Clinton, Jimmy Carter or even the Great Texas Porker, Lyndon Johnson, dared to utter the thought of it — at least not in polite company.
Suddenly, and notwithstanding all the good he has done disrupting the status quo, the Donald has become the foremost enemy of America’s very financial survival.
The Federal budget is a Fiscal Doomsday Machine. The depository of American wars and entitlements have run rampant. Under the pile drivers of a global empire and the retiring baby boom, it is rapidly propelling the nation toward fiscal catastrophe. That grim outcome is virtually guaranteed if the only remaining safety brake — the debt ceiling — is summarily abolished.
Due to entitlements, debt service and the slow pipeline of appropriated spending there is no such thing as an annual Federal budget or accountability for how much Uncle Sam spends and borrows. Instead, the $4.1 trillion that Congressional Budget Office (CBO) projects the Federal government will spend in FY 2018, and the $563 billion it will borrow, reflects the dead hand of the past.
Entitlements and other mandatory spending alone is projected to reach $2.566 trillion or 63{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} of total FY 2018 outlays.
Another $307 billion will be required for interest on the nation’s $20 trillion public debt, while upwards of half the $1.22 trillion for so-called “discretionary” or appropriated programs also reflects funds appropriated years ago.
Altogether, $3.5 trillion, or 85{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} of outlays, will be essentially baked into the cake before a single Congressional vote is taken on anything regarding the FY 2018 budget.
The Federal spending machine is almost entirely on autopilot and heading for disaster owing to ballooning populations and debt. Ten years from now the combined cost of mandatory programs and debt service will reach $5.12 trillion compared to just $2.87 trillion during FY 2018.
Entitlement spending will be nearly double — even if Congress took a 10-year recess!
As shown below, that means the Federal spending share of GDP is now inexorably climbing toward 30{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} owing to baby boom retirements, even as revenue under current law is stuck at about 18{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} of GDP. The CBO’s latest projection of the widening fiscal gap — soon more than 10{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} of GDP annually — leaves nothing to the imagination.
America really does have in place a Fiscal Doomsday Machine.
The Fiscal Doomsday Gap Is Uncloseable — The Crisis Is Permanent
In the chart above, it is easy to see why the beltway argument — that we’ve already spent the money and must liquidate by borrowing whatever it takes — is so thoroughly wrong. The tidal forces driving the budget are so enormous and dangerous that some kind of automatic, institutionalized braking force is absolutely necessary.
The fiscal exigencies of empire, demographics and debt have now become insuperable.
In the case of demographics, it is all right here. The baby boom is retiring at a rate of 10,000 per day, and the wave will not crest until there are nearly 100 million Americans over 65 years of age — double today’s 50 million.
Needless to say, at an average cost of $35,000 per year for retirement pensions and medical care alone, the fiscal math becomes prohibitive.
The voting and political math is downright impossible, and has been that way for the last 34 years.
The last time any significant chunk was taken out of social security or medicare benefits was back in 1983 when the Congress did agree to the Greenspan Commission’s proposal to delay the payment date of the Social Security cost of living allowance (COLA) by the grand sum of 90 days on a one-time basis!
There was one other change, that I was personally involved in, that seals the case. Working with Greenspan we had narrowed the benefit cut options down to a binary choice and presented it to the swing vote on the commission. The latter happened to be 88 year-old Claude Pepper — a left-over from the New Deal era and champion of America’s elderly lobby.
Did he want a reduction in early retirement benefits immediately or an increase in the retirement age starting 30 years hence? Apparently, Senator Pepper concluded he would not live to be 118, and choose the second option!
All of that happened when the over 65 population was about 28 million, not 100 million.
Housing Bubble Symmetry: Look Out Below
by Charles Hugh Smith, OfTwominds:
Housing markets are one itsy-bitsy recession away from a collapse in domestic and foreign demand by marginal buyers.
There are two attractive delusions that are ever-present in financial markets:One is this time it’s different, because of unique conditions that have never ever manifested before in the history of the world, and the second is there are no cycles, they are illusions created by cherry-picked data; furthermore, markets are now completely controlled by central banks so cycles have vanished.
While it’s easy to see why these delusions are attractive, let’s take a look at a widely used measure of the U.S. housing market, the Case-Shiller Index:
If we look at this chart with fresh eyes, a few things pop out:
1. The U.S. housing market had a this time it’s different experience in the 2000s, as an unprecedented housing bubble inflated, pushing housing far above the trendline of the Case-Shiller National Home Price Index.
2. It turned out this time wasn’t different as this extreme of over-valuation collapsed.
3. For a variety of reasons (massive central bank and state intervention, the socialization of the mortgage market via federally guaranteed mortgages, historically low mortgage rates, massive purchases of mortgage backed securities by the Federal Reserve, etc.), the collapse in prices did not return to the trendline.
4. There is a remarkable time symmetry in each phase of expansion and collapse; each phase took roughly the same period of time to travel from trough to peak and peak to trough.
5. The Index has now exceeded the previous bubble peak, suggesting this time it’s different once again dominates the zeitgeist.
6. Those denying the existence of cycles have difficulty adequately explain away the classic cyclical nature of the 2000-2008 bubble rise and its collapse, and the subsequent expansion of housing prices in a near-perfect mirror-image of the first housing bubble’s steep ascent.
Claiming that this painfully obvious time symmetry is mere randomness/coincidence is not an explanation.
7. This time symmetry suggests that the current housing bubble is close to its zenith and will likely collapse over a time frame similar to Housing Bubble #1.
The basic arguments for ever-higher housing prices forever and ever are:
A. central banks completely control all markets, including housing, and they will never let the housing market decline ever again.
B. Foreign buyers paying cash (even if the “cash” was borrowed in Asia) will continue flooding into North America, elevating markets for the the foreseeable future.
The omnipotence of central banks is a matter of near-religious certainty among the faithful, but skeptics note that central banks have played major roles in markets for decades, yet every asset bubble eventually pops despite central bank/state management of markets.
True believers note that the central state/bank interventions have greatly expanded, and that there are no limits on future interventions; central banks can create trillions of dollars, yuan, yen, euros, etc., and use this “free money” to buy assets, propping up markets indefinitely.
In this line of thinking, central banks/states “learned their lesson” in the first housing bubble and will never let the housing market collapse again.
As for foreign demand: the number of buyers from China who are desperate to turn their cash into North American real estate holdings is practically limitless.
The counter-arguments are:
1. Despite the federal guarantees on mortgages, the housing market is still dominated by private-sector borrowers and lenders. As my colleague Mish has often pointed out, central banks/agencies cannot force people to borrow money to buy homes, vehicles, etc.
If everyone who is qualified to buy a house and wants to buy a house has bought a house, then demand is limited to new households and foreign buyers.
New household formation has recovered a bit but is still at historically low levels. New households burdened by student loan debt, high rents and stagnant wages are not qualified to borrow hundreds of thousands of dollars to buy homes at current nose-bleed valuations.
While the number of foreign buyers may appear to be limitless in specific markets, counting on marginal buyers with cash to prop up markets across the board is an iffy proposition, given the potential for conditions to reverse due to global recession, capital controls, higher taxes imposed on foreign owners of vacant homes, etc.
I would argue that this time is different, but not in a healthy way. Central bank/state interventions in the market have drawn in marginal borrowers who are a few paychecks away from default, and speculators who are leveraged to the hilt to buy homes to “flip for quick profits–a strategy that collapses if qualified buyers become scarce.
Globally, housing has become a flight-to-safety asset for the global elites, a development with disastrous consequences for residents. Housing owned for investment often sits empty, effectively withdrawing much-needed housing units from the market for shelter. This investment buying reduces the pool of available housing, driving up rents and home prices, pushing shelter out of reach of the bottom 95{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} of wage earners in desirable urban areas.
Read More @ OfTwoMinds.com
The Most Momentous 72 Hours in Fed History
by Jim Rickards, Daily Reckoning:
A 72-hour span last week was among the most momentous for the Federal Reserve in the over 100-year history of the U.S. central bank.
Many Fed watchers would be completely baffled by that statement.
Fed watchers are mesmerized by minute changes in grammar and syntax contained in the statements of the Federal Open Market Committee (FOMC), the Fed group that sets interest rates.
At the last Federal Open Market Committee (FOMC) meeting, on July 26, the Fed did nothing. The Fed’s Jackson Hole, Wyoming, summer meeting came and went at the end of August with scarcely a word said about interest rate policy. The next FOMC meeting is not until Sept. 20. In short, we’re in the midst of a rare period when nothing seems to be going on at the Fed in terms of rate policy.
How could last week have possibly produced a momentous 72-hour period?
The answer is that institutions boil down to people, not calendars, and Fed people have just made a lot of headline news.
Last Tuesday morning, Sept. 5, Fed governor Lael Brainard delivered one of the most significant Fed speeches ever. Translating from Fed-speak to plain English, she more or less admitted the Fed has no idea how inflation works.
Brainard pointed out that the Fed began its current monetary policy tightening cycle in the belief that tight labor markets implied inflation was coming with a lag. The Fed raised rates in December 2015, December 2016, March 2017 and June 2017 in part to get out ahead of this coming inflation.
Instead the opposite happened.
The Fed’s favorite measure of inflation plunged from 1.9{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} to 1.4{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} between January and July 2017 even as job creation continued and the unemployment rate fell. In other words, the relationship between tight labor markets and inflation turned out to be the exact opposite of what the Fed believed. Their models are in ruins.
Of course, this is what I’ve been telling my readers to expect all year. The Fed was tightening into weakness, not strength, and would soon have to flip back to ease in order to avoid an outright U.S. recession. And ease is exactly what Brainard called for in her speech. Brainard had a three-part remedy for disinflation…
The first part was the use of forward guidance to signal that Fed rate hikes were on hold indefinitely. This is a form of ease relative to market expectations of further hikes.
The second part was to raise inflationary expectations by making public statements about the forward guidance. This is similar to the “Think System” used by Professor Harold Hill in the musical The Music Man.
Hill is a con artist who sells instruments to school kids. He can’t teach music but tells the kids if they will “think” hard enough, they can play! Brainard says if we all think inflation is coming, it will come. Her odds of success are about the same as Professor Hill’s, who is almost run out of town by an angry mob.
The third part is the most interesting. The Fed has a “target” of 2{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} inflation but has implicitly treated the target as a cap. Brainard said, in effect, that if your target is 2{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} and you’ve been below that for five years, it’s OK to run above 2{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} so that the long-term average hits the goal.
This means she’s OK with 3{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} inflation, a sentiment also expressed by Chicago Fed President Charles Evans. Inflation at 3{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} cuts the value of a dollar in half in 24 years. Brainard and Evans think the Fed can dial it back if needed, but 3{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} inflation could just as easily turn into 4{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} or 5{5f621241b214ad2ec6cd4f506191303eb2f57539ef282de243c880c2b328a528} inflation once expectations really do change.
Then on Wednesday morning, Sept. 6, Fed Vice Chairman Stanley Fischer unexpectedly announced his resignation effective almost immediately. He said his reasons were personal, and I actually believe that. I met Stan back in my days at Long Term Capital Management; he was thesis adviser to several of my partners there. I wish him well.
But this resignation now means that four of the seven Fed board seats are now vacant.
One nomination by Trump is pending (Randy Quarles), but that still leaves three more nominees to fill the board. And that’s not counting Janet Yellen, whose term as chair expires at the end of next January. All in, Trump will get to name five out of seven Fed governors in less than one year after being sworn in as president.
I told my readers months ago that “Trump owns the Fed,” and that reality is playing out even faster than I expected then.
Finally, last Wednesday afternoon, Sept. 6, the White House leaked to Axios that Gary Cohn, Trump’s top economic adviser and the former chief operating officer of Goldman Sachs, was out of the running to replace Janet Yellen. This also confirms what I said months ago, that Kevin Warsh is the likely next chair of the Fed.
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