Musings Report #38 9-16-12 The Fed Has Failed
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The Fed Has Failed
If you aren't particularly interested in finance, don't stop reading just yet, for the Federal Reserve's decision to go "all-in" last week with unlimited monetary easing is far more interesting than it might seem. (The European Central Bank also has gone "all-in, announcing unlimited purchases of sovereign bonds.)
This "all-in" is the high water mark of the central banks' legitimacy, which can only decay from here as the failures of their policies mount.
It also marks the crossing into a peculiar cultural wilderness where the nation's central bank is explicitly attempting to fix the broken, sluggish economy--a real world phenomenon--by manipulating the internal psychological state of the populace. The "wealth effect" is entirely a state of mind, a mix of perception and trust in the legitimacy of Status Quo.
That the Fed felt compelled to launch an unlimited printing campaign in support of housing (by buying mortgages) and Federal debt (by buying Treasury bonds) is proof that their policies have failed. Faced with their undeniable failure to "restart the economy," the Fed has thrown everything it has into the fire.
We all know the Federal Reserve exists for one purpose--to protect the wealth and power of the banks. This is evidenced by one question: does the Fed loan funds at 0% to households or communities? No. It loans "free money" at 0% to the banks so they can loan money to students at 7%. When the banks get in trouble, the Fed rushes to loan them $29 trillion. When a student gets in financial trouble, he is hounded for the rest of his natural life, as the debt cannot be discharged in bankruptcy like every other form of debt.
Despite the transparency of its raison d'etre, the Fed presides in a nominal democracy and thus faces political pressure if its public PR purposes--maintaining stable prices, i.e. moderate inflation, and full employment--are clearly failing. The Fed thus needs to "manage perceptions" to maintain its facade of omnipotence and competence.
Did you see any of Chairman Bernanke's testimony? It was painfully obvious that either 1) he was high on Ibogaine or 2) he was just going through the motions, repeating PR that he himself does not believe.
Here is the critical quote:
"If people feel that their financial situation is better because their 401(k) looks better for whatever reason, or their house is worth more, they are more willing to go out and provide the demand."
The key phrase here is "for whatever reason." In other words, it doesn't matter how artificial or phantom the increase in their assets may be, any increase is presumed to be good enough to trigger a "wealth effect" euphoria and a pressing urge to borrow and spend money.
I think it is clear Bernanke's policies have failed to spark a "wealth effect," even though the stock market has more than doubled from its March 2009 lows. The reason for this is self-evident: 91% of all stocks and bonds are owned by the top 10%. The bottom 90% feel little if any wealth effect from a new bubble in equities.
The other factor is the perceived legitimacy of the asset expansion. People have been burned twice in one decade by asset bubbles blown by the Fed, and they can see the difference between an organic expansion of assets (from a healthy increase in demand driven by higher wages and productivity) and a central-planning bubble based on shadow intervention and massive money-printing.
I also suspect Bernanke's "all-in" bet has a political angle. As a student of the Great Depression, Bernanke is keenly aware of the conventional criticism (mostly wrong, it turns out) that the Fed "didn't do enough" in the Depression.
Since it is clear that the economy is sliding into recession, Bernanke is going all-in now as a pre-emptive strike against any critics who might later claim he "didin't do enough." He knows that QE3 won't boost incomes or jobs, but he launched it as a form of defensive policy against the inevitable future criticism that the Fed 'didn't do enough."
Now he can shrug and sigh, "We did everything possible." The blame will fall elsewhere, and the Fed will have a free hand to continue its "bank wealth defense," enabling the banks to borrow at 0% and reap high profits.
Bernanke knows QE3 will fail, but he doesn't really care. His job is to protect the Fed's political power and the bank's wealth. He is doing an excellent job at this "real" job while failing catastrophically at his PR job of boosting employment.
Market Musings
As you know, I've been following the SPX-VIX ratio chart which tracks the S&P 500 and the VIX measure of volatility as potentially useful gauge of market extremes. This ratio caught the low rather well two weeks ago and flashed a "caution" last week before the Fed's announcement of QE3.
This ratio has reached levels that marked previous highs. It top-ticked the May 1 high within a day or two, and also top-ticked the August 20 high. Though no indicator is perfect, of course, this indicator picks up both the movement of the SPX and market sentiment (VIX). Sentiment is extremely complacent, as evidenced by headlines such as "U.S. stocks poised to move higher on QE3 tailwind."
From a purely technical perspective, things look rather stretched. As my first stock market mentor Stew P. used to remark, when all the good news is out then there is nothing left to drive prices higher. Eventually the odds favor the next bit of news being bad, and so the "surprise" will also be negative.
From Left Field
"Everything is incredible"--an artful 10-minute film about an elderly gent in South America, the process of creating, and about the human condition. (via G.F.B.)
The Cult of Disappearing Design-- the Japanese have long valued a spartan interior, and it doesn't require high tech: a closet for the futon bed is sufficient....
Vanishing into Nature--high-end housing design; pretentiousness abounds (a $15,000 chaise lounge? Let them eat cake), but some of the ideas could be incorporated in a much less expensive dwelling.
If you have ten thousand regulations, you destroy all respect for the law." Winston Churchill
Thanks for reading--
charles