Stock valutations in the United States are no longer driven by profits, future earnings, productivity or any other free market measure of value. Instead they are controlled, in practice by President Donald Trump trade war tweets and Fed Chair Jerome Powell’s comments about future interest rate levels.
These two economic central planners met on Monday the 18th to talk about “Everything”.
Trump has already made clear he wants negative rates and more quantitative easing. He mentioned discussing negative interest rates with Powell.
“Trump called the meeting ‘very good & cordial,’ adding that ‘everything was discussed,’ including interest rates, negative interest, low inflation, easing, dollar strength, and its effect on manufacturing, trade with China, the EU ‘& others, etc.'” (Emphasis added)
Powell sounded like a 3 year old parroting some rehearsed line, stating monetary policy will be set to support maximum employment and “stable prices”.
The Fed’s target for price inflation is 2%. Which means that the value of a dollar will be cut in half in about 36 years. This is hardly what I would consider to be price stability.
On the topic of “maximum employment”. The unemployment rate is at a half-century low of 3.6%. To have a lower unemployment rate you have to go back 50 years to 1969.
Do interest rates need to be below the level of inflation in order to support maximum employment?
A Health Person on Life Support
Interest rates are at 1.75% and central bank balance sheet growth has resumed. These are the kind of extraordinary life support measures seen during economic crashes and recessions.
If the economy is healthy, vibrant, growing and strong you don’t need to pump it up with stimulants and preventative measures. Yet these extraordinary measures have been going on for a decade.
Say you have a patient in a hospital. The doctor says they are fine and doing great. However, we’re going to pump them full of antibiotics, keep a morphine drip and IV going, and hook them up to an iron lung, “just in case”.
You would rightfully be suspicious of that doctor. If the patient is fine then why do they need all of those extraordinary life preserving measures?
It seems clear to me the Fed is keeping interest rates low for some reason other than price stability or supporting maximum employment.
Central planners President Donald J. Trump and Fed Chair Jerome Powell both spoke regarding the US Economy this week. Trump was Tuesday; Powell Wednesday.
One interesting quote from Chair Powell’s prepared remarks were the following: “Nonetheless, the current low interest rate environment may limit the ability of monetary policy to support the economy.”
In other words if the economy goes south, the Fed won’t be able to do much to prop it back up.
This assumes rates don’t go negative (like Trump is already calling for) or Quantitative Easing (QE) isn’t further expanded (which Trump has also called for). With those in mind, the Fed still has tools at it’s disposal to wreck the dollar and re-inflate asset bubbles.
Powell also read, “In a downturn, it would also be important for fiscal policy to support the economy. However, as noted in the Congressional Budget Office’s recent long-term budget outlook, the federal budget is on an unsustainable path, with high and rising debt: Over time, this outlook could restrain fiscal policymakers’ willingness or ability to support economic activity during a downturn.”
As he states the obvious, Powell is of course correct about the unsustainable federal budget.
Seeing as how the Fed is empowering the Treasury to go deeper and deeper into debt it is ironic that the Chair of the Fed is concerned about the debt.
Powell also mentioned his “In no sense, is this QE,” Quantitative Easing program: “To achieve this level of reserves, we announced in mid-October that we would purchase Treasury bills at least into the second quarter of next year and would continue temporary open market operations at least through January. “
The reasoning goes that because they intend to shrink their balance sheet they aren’t just conjuring money created out of thin air.
But this is dependent on balance sheet normalization. Indeed, starting under Fed Chair Janet Yellen and accelerating under Fed Chair Jerome Powell the balance sheet had been trending down from the January 2015 high–at least until August 2015.
But as of 28 October 2019 the Fed’s balance sheet is back above $4 trillion. As humans we tend to place greater significance on large whole numbers when in fact there is nothing special about $4 trillion. But the point is that the Federal Reserve balance sheet began to tick back up starting in September of 2019.
What happens in the Next Recession?
Was the balance sheet declining from $4.5 trillion in January of 2015 down to $3.7 trillion in August of 2015 the extent of the “normalization” process?
The S&P 500 is making all time highs, everything is supposed to be wonderful in the economy, and yet starting back in September the Fed’s balance sheet is growing again, quite rapidly in fact as evidenced by the steepness of the chart.
How can the Fed ever normalize if they can’t do it after 10 years of stock market growth?
The above chart only goes through 2018. But it does show that the Fed’s balance sheet is correlated with the S&P 500. Despite the balance sheet tapering off slightly from 2016 onward through mid 2018 the S&P 500 continued to grow, until it sold off rather significantly in December.
Since December the S&P 500 has rallied back and achieved new highs. All told, the S&P 500 has gone up nearly 350% since the March 2009 lows.
An intrepid investor who purchased the S&P 500 in the dark days of March 2009 would have done very well. However, I believe this artificial “growth” is really a bubble blown by the Federal Reserve.
If this “growth” has been fueled by the Fed’s monetary policy, then the Fed can’t even normalize without also tanking the markets.
Combine this with trillion dollar annual budget deficits and $23 trillion in national debt, the US simply doesn’t have any ammunition to fight the next economic downturn, at least not without seriously compromising the value of the dollar.
US stocks have been the investment strategy for the past ten years. But this is the longest period of economic expansion in the history of the United States.
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