Let’s get real and Fire the Fed!


Ding Dong! The Witch is dead. Which old Witch? The Wicked Witch!
Ding Dong! The Wicked Witch is dead.
Wake up – sleepy head, rub your eyes, get out of bed.
Wake up, the Wicked Witch is dead. She’s gone where the goblins go,
Below – below – below. Yo-ho, let’s open up and sing and ring the bells out.
Ding Dong’ the merry-oh, sing it high, sing it low.
Let them know
The Wicked Witch is dead!
                                                Wizard of Oz

Commentary & Analysis
Let’s get real and Fire the Fed!

Is the word “gutless” too harsh a description of the FOMC members? Or maybe I have it completely wrong, as it takes guts to take such a haphazard leap into monetary experimentation at such a critical time for the US and global economy. I think there is arguable evidence to suggest QE1 made some sense. But the evidence trail flowing from QE2 is increasingly confirming it has been a dismal failure for most of us.

If the objectives of Quantitative Easing 2 (QE2) were to: a) raise interest rates; b) slow economic growth; c) encourage speculation, and d) eviscerate the standard of living of the average American family, then it has been enormously successful. Clearly, with the benefit of 20/20 hindsight these results represent the Federal Reserve’s impact on the U.S. economy, regardless of their claims to the contrary.
                                                Hoisington Investment Management

Of course those with the money to speculate, including hedge and mutual fund managers, and other rich folk, likely believe the Fed has done a splendid job. In fact, most of these types show up on CNBC to tell us just that. But if you are a real person doing a real job in the real economy, not the financially fabricated one of money managers, you know the Fed needs to be fired! You know you would, if you ever performed that badly.

I have to admit, till recently I was quite split on this issue as to whether or not the Fed has failed, as I perused the US inflation picture. In Currency Currents past I wrote that bank reserves do not constitute money, in the real sense, thus until we see some change in monetary velocity we won’t see inflation. A reader wrote to scold me, a few months back, about this view. He said, “there are leakages–you idiot.” Well, I think he was right.

It is the leakages through use of all these bank reserves as basic free margin credit for the big boys that have done the dirty deed; it’s no surprise why fund managers are Fed defenders. Heck, if real people got access to all this free credit the Fed has generated, we’d likely approve of them too. Instead, the misery index settles heavily upon the unwashed.

In Hoisington’s most recent economic review, they make this key point [our emphasis]:

According to the outstanding monetary researcher, Rod McKnew, Ph.D. of Newedge, the Fed facilitated inflation through a more direct channel than expectations. He points out that reserve balances, which are not money, increased much more than money. In the past two years, M2 rose 6% while total reserves jumped 85%. But this does not mean that unused reserve balances had no influence on prices, and in particular on commodity prices. To quote McKnew, “In a world of advanced derivatives, high cash balances are not required to take speculative positions. All that is required is that margin requirements be satisfied.” With reserve balances at unprecedented levels, margin risk is minimized for those market participants who wish to take positions consistent with the Fed’s goal of higher inflation and have either direct or indirect access to the Fed’s mammoth reserve balances, which can satisfy margin requirements.

These activities, while profitable to speculators in the short run, slow real economic activity in several ways. First, the rising interest rate environment also raises mortgage rates (Table 1). Of course this means more marginal buyers are priced out of the market and unable to purchase homes. Is it any surprise that this beleaguered sector of the economy has taken another leg down in terms of sales and price (Chart 2 & 3). Consequently, this sector has become more of a drag on economic growth. Second, homes happen to be the largest net worth asset on consumer balance sheets, and the prospect of their largest asset moving lower in price hardly inspires greater willingness to spend.

Third, the speculation encouraged by the Fed has led to near record margin debt in the stock exchanges, and has raised stock prices, benefiting the upper income segment of society. Further, the open-ended credit lines for speculation have assisted in lifting commodity prices dramatically during QE2, just as they did in QE1 (Table 2). Commodity and stock price movements are susceptible to a myriad of
demand/supply factors that include cartels, war, and weather. But the speculation created by QE2 suggests financial players are aiding and abetting the normal price movements. Evidence of this is the Commitment of Traders Report which indicates record speculation. Also, supply disruptions have not been evident in the gold and silver markets, which suggests that speculation is a dominant force in two of the markets where price increases have been most rapid.

The combination of a rise in interest rates, stock prices, and food and fuel commodity prices has reduced disposable personal income, depressed the net worth of the average American family as home prices have fallen, and caused
consumption to slow, increasing the income divide between the higher and lower income categories.

Hoisington believes the damage done by the Fed can be reversed. But it will take time. They also believe there will be a significant price to pay when the Fed finally does pull the plug on QE2, now scheduled for the end of June. Short-term they expect a decline in growth, a hit to stocks, and a fall in commodity prices. But longer term, the economy should rebound with more healthy and sustainable growth as credit will have an opportunity to finally be released into the real economy as the incentives for pure capital asset speculation fades without Uncle Ben’s backstop.

Hoisington also expects the dollar to rebound once QE2 is history.

So, let’s hope Ben can pull the plug. Then get ready for the dollar to rally in a couple of months, assuming it’s still around by then.

  • JDM

    Thomas Jefferson is credited with stating:

    I believe that banking institutions are more dangerous to our liberties than standing armies. If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around [the banks] will deprive the people of all property until their children wake-up homeless on the continent their fathers conquered. The issuing power should be taken from the banks and restored to the people, to whom it properly belongs.

    The only person, with some political power/fame, who is championing the abolishment of the Federal Reserve is Ron Paul; but he does not have the near fanatical single minded uncompromising and ruthless manner of Old Hickory.

  • Joshua Pearce Gibson

    From Monticello.org~

    This quotation is often cited as being in an 1802 letter to Secretary of the Treasury Albert Gallatin, and/or “later published in The Debate Over the Recharter of the Bank Bill (1809).”

    The first part of the quotation (“If the American people ever allow private banks to control the issue of their currency, first by inflation, then by deflation, the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered”) has not been found anywhere in Thomas Jefferson’s writings, to Albert Gallatin or otherwise. It is identified in Respectfully Quoted as spurious, and the editor further points out that the words “inflation” and “deflation” are not documented until after Jefferson’s lifetime.[3]

    The second part of the quotation (“I believe that banking institutions are more dangerous to our liberties than standing armies…”) may well be a paraphrase of a statement Jefferson made in a letter to John Taylor in 1816. He wrote, “And I sincerely believe, with you, that banking establishments are more dangerous than standing armies; and that the principle of spending money to be paid by posterity, under the name of funding, is but swindling futurity on a large scale.”[4]

    The third part of this quotation (“The issuing power should be taken from the banks and restored to the people, to whom it properly belongs”) may be a misquotation of Jefferson’s comment to John Wayles Eppes, “Bank-paper must be suppressed, and the circulating medium must be restored to the nation to whom it belongs.” [5]

    Lastly, we have not found a record of any publication called The Debate Over the Recharter of the Bank Bill. There was certainly debate over the recharter of the National Bank leading up to its expiration in 1811, but a search of Congressional documents of that period yields none of the verbiage discussed above.

    ↑[3] Suzy Platt, ed., Respectfully Quoted: A Dictionary of Quotations Requested from the Congressional Research Service (Washington D.C.: Library of Congress, 1989; Bartleby.com, 2003), http://www.bartleby.com/73/120….
    ↑[4] Thomas Jefferson to John Taylor, Monticello, 28 May 1816. Ford 11:533.
    ↑[5] Thomas Jefferson to John Wayles Eppes, Monticello, 24 June 1813. Ford 11:303.

  • Joshua Pearce Gibson

    “The problem with internet quotes is, you never know if they’re legitimate or not.” ~Abraham Lincoln