George Orwell’s dystopian book “1984” introduced the world to the concept of Newspeak. Newspeak is the process of redefining words for political purposes. Examples in the book include, “War is peace. Freedom is slavery. Ignorance is strength.” There are plenty of examples of Newspeak today in the United States and doubtless throughout the world. The United States Federal Reserve is a terrible offender when it comes to the use of Newspeak. Below are several examples.
Federal Reserve Newspeak: Price Stability
Part two of the Federal Reserve’s “Dual Mandate” is “Price Stability.” However, the Federal Reserve actively undermines price stability. Here is a quote from the St. Louis Federal Reserve website:
Price stability: If prices for goods and services are stable, that preserves the purchasing power of money. The Federal Open Market Committee, or FOMC, has equated price stability with a low, measured rate of inflation. (Inflation is a general, sustained upward movement of prices for goods and services in an economy.) To achieve this part of the mandate, the FOMC targets an inflation rate of 2 percent over the longer run.
Why is this newspeak? Two percent inflation is not stable. If a ship is losing 2% of its buoyancy every year it will eventually sink. Take a worker who makes $15 an hour. After 20 years, at a 2% inflation rate, that money is now worth $10.09. That “stable” price stability cut a workers wage by a third.
Price stability actually means prices neither rising nor falling.
Of course the real rate of price increases is well above 2%–more on that later.
So when the Federal Reserve use the term “Price Stability” what they really mean is rising prices and a steady erosion of the purchasing power of the dollar.
Federal Reserve Newspeak: Balance Sheet Normalization
The US Federal Reserve makes available their “recent balance sheet trends.” The Federal Reserve narrative of their balance sheet trends is as follows:
The Federal Reserve’s balance sheet has expanded and contracted over time. During the 2007-08 financial crisis and subsequent recession, total assets increased significantly from $870 billion in August 2007 to $4.5 trillion in early 2015. Then, reflecting the FOMC’s balance sheet normalization program that took place between October 2017 and August 2019, total assets declined to under $3.8 trillion. Beginning in September 2019, total assets started to increase.
There is lots of Newspeak in that paragraph. I will give the Federal Reserve some credit, as one sentence doesn’t need too much translation “During the 2007-08 financial crisis and subsequent recession, total assets increased significantly from $870 billion in August 2007 to $4.5 trillion in early 2015.” Here is the translation:
The Federal Reserve’s balance sheet has significantly expanded over time. During the 2007-08 financial crisis and subsequent recession, total assets more than quadrupled from $870 billion in August 2007 to $4.5 trillion in early 2015. Then, the FOMC’s balance sheet normalization program that took place between October 2017 and August 2019 failed and the balance sheet was only able to be reduced back to about $3.8 trillion which is still 3.3 times higher than it was prior to the 2007-2008 financial crisis. Starting in September of 2019 the balance sheet started to grow again. In the year long period between March 2020 to March 2021 the balance sheet increase by over 80% and is currently almost 8x higher than it was back in July of 2007
Balance Sheet normalization in actual english would mean reducing the balance sheet from $4.5 trillion back to under $1 trillion. But in Federal Reserve Newspeak it means reducing the balance sheet 17% from the highest it had been up to that point, going from $4.5 trillion down to $3.8 trillion and then proceeding to more than double it up to $7.7 trillion.
Federal Reserve Newspeak: Tools to Fight Inflation
Fed Chair Jerome Powell has talked about how he has the tools to fight inflation. This is arguably just a lie and not Newspeak, but since Newspeak is a way of lying this distinction doesn’t matter. The translation of this statement is that the tools the Federal Reserve will use to fight inflation will be to ignore and downplay that inflation exists and claim it is transitory.
The Federal Reserve was previously targeting a 2% reduction in the value of the dollar per year. Now that the CPI is officially over 2%, the Federal Reserve is saying this is transitory and that because there were periods of time in which inflation was under 2%, it is okay to be above 2% now.
So the Federal Reserve starts by using a number that is already too low (2.6% instead of 6%) then redefines price stability to mean 2%. So we’re really only seeing a 0.6% increase in prices and that is transitory.
Meanwhile, the only real tools the Federal Reserve has to fight inflation would be to shrink its balance sheet and raise rates. But this would tank the stock market and make it too expensive for the US government to borrow money.
In US Federal Reserve Newspeak, “Price Stability” is rising prices. “Balance Sheet Normalization” is doubling. “Fighting inflation” is ignoring it.
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. “
Despite the fact that he is now 100% complicit in blowing a giant bubble that will eventually destroy the US economy as we know it, Trump is looking like a game theory genius.
Trump as Bagholder
Before he took office Trump knew the stock market was in a “big, fat, ugly bubble”.
Of course after he took office that capacious and ill-favored looking bubble magically transformed into a beautiful example of legitimate growth thanks to President Donald J. Trump parking his rump in the oval office. But I digress.
I thought the powers that be were going to crash the stock market in time for Trump to be defeated by whichever Democrat candidate manages to climb over the metaphorical bodies of the other ones.
Meanwhile Trump got the beginnings of a tightening cycle. In other words, under Obama everyone got drunk and partied, but when Trump took over the booze started to get packed up and the markets began to sober up with a nasty hangover.
However, by using tariffs Trump is forcing the US Federal Reserve to cut interest rates. This will re-inebriate the markets and probably ensure his re-election.
Trump will keep doing erratic tariff threatening, forcing the Fed to lower rates, until rates are as low as Trump wants, then he’ll declare victory in the trade war. The removal of the trade war worries coupled with low interest rates would rally the markets skywards like bubbles in a tornado.
Trump has found a way to avoid being the bag-holder of the next stock market crash, at least until his second term.
At least that is the theory to which I subscribe.
The Fed Doesn’t Want to be Blamed
One potential problem with this theory is that if the Fed really was out to get Trump, they could simply ignore his antics, hike rates and that combined with the tariffs would cause the markets to sell off, a lot, and probably trigger the next great depression and ensure that Trump couldn’t win the 2020 election against the devil himself.
However, Trump has talked about the Fed a lot, and put them more in the spotlight, so if the markets do crash, they might be afraid that Trump will successfully be able to blame them. So while the Fed would like to tighten, and lay the blame of the market crash at Trumps feet, they are afraid of Trump on the bully pulpit saying that the Fed crashed the markets and causes the recession.
So they essentially are caving to his desires to avoid being perceived as the bad guys. I think this explains why, against all conventional wisdom, with the markets at all time highs, price inflation as measured by the CPI near the 2% target, and low unemployment, the Federal Reserve cut rates.
If they had continued to tighten, while Trump was complaining about them, they might get blamed and they can’t have that.
At the same time they don’t want to look like they are not “independent” as they are so proud of claiming, so they can’t do the full 50 basis point cut and start easing, as it will look as though they are just following orders.
Trump Turns to Twitter
Consider that yesterday, July 31st 2019 Powell’s Fed cut rates by 25 basis points, but indicated it was basically a one and done insurance cut and not the start of a new easing cycle.
Mr. Market didn’t like this and sold off with only a modest partial rally going into the close as you can see from the SPY chart below.
Now at around 10am on August 1st the S&P 500 had rallied back to about where it was before Jerome Powell spoiled the party with a paltry 25 basis point cut and jaw-flapping about this not being the start of a new easing cycle.
Trump is fond of taking credit for the stock market highs, as Presidents are wont to do, so he wouldn’t throw cold water on the post rate cut rally, right?
Wrong, sir! Wrong!
By announcing new Tariffs on China he stopped the rally dead in its tracks.
Why? Because Trump wanted the Fed to cut 50 basis points and he wants an easing cycle.
So the market tanks down even lower than it was before, and the odds of a rate cut in September increases from less than 50% up to 84%!
I should be mad at Trump for encouraging bubble blowing and what is incredibly destructive economic policy, but I have to admit I’m impressed with his gamesmanship.
A lot of people can’t see past Trump’s third grade vocabulary and “unpresidential” comportment–this causes them to underestimate him. I think Trump is good at persuasion and he understands perception and negotiation.
If it continues to work I think he’ll be re-elected. Of course it means that the day of economic judgment, while postponed will only be worse later.
On the bright side, investments in gold are looking quite shiny. And if the market doesn’t crash on Trump’s watch free markets won’t get wrongfully blamed.
Even though laissez-faire he is not, Trump does represent capitalism in the minds of many, and if the market crashes on his watch the United States will unfortunately pivot violently even more to the left.
A few weeks ago on the 20th of September the United States Federal Reserve announced it would begin unwinding it’s $4.5 trillion balance sheet starting in October. The Federal Reserve undertook unprecedented action in the wake of the 2008-2009 financial crisis when it expanded it’s balance sheet from $900 billion to as high as $4.5 trillion in order to buy worthless mortgage backed securities and other assets that no one else would–as well as government bonds.
As the Fed unwinds it’s balance sheet by selling assets and not rolling over existing assets, the money supply in circulation will shrink.
If the money supply shrinks will the value of the S&P 500 as well?
So why does this matter? Well, as pointed out at the beginning of the year over at Benzinga.com, the S&P 500 is 97% correlated with the Adjusted Monetary Base. As the Adjusted Monetary Base goes up, so does the S&P 500, as the Adjusted Monetary Base goes down, the S&P 500 goes down.
The Adjusted Monetary Base is the sum of currency (including coin) in circulation outside Federal Reserve Banks and the U.S. Treasury, plus deposits held by depository institutions at Federal Reserve Banks.
So the by reducing it’s balance sheet, the Fed will lower the Adjusted Monetary Base and thus the S&P 500 would experience downward pressure.
But that isn’t the only headwind.
Reduction in Share Buybacks
The Federal Reserve lowered interest rates to near zero for almost seven years. Low interest rates means it’s less expensive to borrow money. A lot of companies have taken advantage of these low interest rates to issue bonds (a way of borrowing money) at low interest rates and then used the proceeds not to invest in people, factories, or equipment, research and development or other business growing endeavors, but instead to use the borrowed money to buy back their own shares.
Bond issues increases the debt companies have on their balance sheets, but also boosts their share prices, even when the companies aren’t performing any better. An example Simon Black of Sovereign Man uses is Exxon Mobil. Exxon is #4 on the Fortune 500.
In 2006, the last full year before the Federal Reserve started any monetary shenanigans, Exxon reported $365 billion in revenue, profit (net income) of nearly $40 billion and free cash flow (i.e. the money that’s available to pay out to shareholders) of $33.8 billion.
At the time, the company had $6.6 billion in debt.
Ten years later, Exxon’s full-year 2016 revenue was $226 billion, net income was $7.8 billion, free cash flow was $5.9 billion and the company had an unbelievable debt level of $28.9 billion.
In other words, compared to its performance in 2006, Exxon’s 2016 revenue dropped nearly 40%, due to the decline in oil prices.
Plus its profits and free cash flow collapsed by more than 80%. And debt skyrocketed by over 4x.
Despite the article image and title I certainly don’t know that October will see the stock market dip into the red. It would make sense if it did, but the S&P 500 continues to make new highs in spite of the Federal Reserve tightening, lackluster GDP growth and saber rattling from both North Korea and the United States.
But it is another headwind.
At some point there will be a stock market correction. That is simply how markets work since the advent of central banking and hence the business cycle. It has take much longer than I expected for there to be a correction. I didn’t believe that President Barrack Obama would leave office without seeing a stock market crash, but he did.
But markets have been on a steady climb since early 2009 and the bull market is looking long in the tooth. The S&P 500 could continue to rise for the foreseeable future, but with this new headwind of balance sheet reduction in addition to interest rate hikes, it might be time to take some dollars off the table and pivot some assets into alternative opportunities.
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