Let’s be perfectly clear, I am not about to violate the first and third Commandments by implying the Federal Reserve (FED) is divine; that said, one must wonder if the common parlance of “the almighty US Dollar”, which is in conflict with the second Commandment,will direct some folk South in the afterlife.
No matter –if a thirty-five-year career as a mortgage derivatives trader has not already condemned me to a slow ride down the Styx, then I am likely safe to pen a Commentary about the FED exercising its absolute power over the financial system.
A clever eye will notice that I did not say “U.S. financial system”, and this was intentional. Since the USD still maintains its reserve currency status garnering perhaps two thirds of international trade, domestic FED policy is effectively Global monetary policy.Today,I consider the implications of the FED’s newly stated “guidance”, and a few investment ideas that feed directly from its policies.
Across the spectrum, it has become an inconvenient truth that facts contrary to one’s opinion are bothersome.Two such facts that receive no respect are: 1) Fiat currency created by the Central Bank at a rate greater than economic growth will eventually lead to inflation; and 2) The yield level of risk-free interest rates will have an impact upon the value of other assets....MUCH MORE (9 page PDF)
Supporters of Modern Monetary Theory rest their heads upon the soft pillow of the FED’s balance sheet -maya bars-exploding over the past decade while the Consumer Price Index (CPI) has barely pulsed a heartbeat.This is utter nonsense; just because I have never been struck by lightning does not encourage me to swing a five-iron in a thunderstorm. Of course,the excessive creation of fiat currency leads to inflation;if it didn’t, I can assure you there would be a shelf of books detailing such miracles over the past five thousand years of recorded history.
The lack of inflation should not distract one from recognizing that our financial economy is presently overwhelmed by too much debt, both public and private; this is what necessitated the FED’s introduction of an alphabet soup of asset support/purchase programs.
GDP = Money * Velocity= Price * Quantity
There are only two ways to resolve a debt crisis –either default or inflate with the caveat that inflation is simply a slow-motion default. (Yes, strong real GDP growth can also extinguish debt, but let’s stipulate this avenue as closed.
So far, old school FED economics has not worked as planned.Despite a massive increase in Money(M2), the Velocity of money has declined at a similar pace.
Ever so clever, the FED seeks to increase Monetary Velocity via Financial Repression to create inflation that will depreciate nominal debt to de-lever both the public and private balance sheets.
The FED reduced its overnight interest rate target to near zero at the start of the Great Financial Crisis (GFC), but this could not halt the decline in the Velocity of money. A possible explanation is that risk takers (both businesses and investors) were uncertain how long they could cheaply fund their activities....
All of which is why, dear reader, we post this chart from time to time:
The money released by Fed machinations isn't turning over. It is getting stuck in the financial system.
Helicopter money for financiers is all well and good but it doesn't address the problem.
(it's the same picture for MZM and M2)
See also:
Redistributing Wealth Upward
Fed Rate Cut: Chairman Powell Just Showed President Trump Why You Should Be Careful What You Wish For
And from 2010:
Modern Economists Misinterpret Quantitative Easing
Recently from Mr. Bassman:
Convexity Maven: When The Fed Will Lose Control
The Convexity Maven Rages Against The Fed (and potentially Professor Shiller too)
Convexity Maven: "I Picked the Wrong Week...”
