Yellen’s Gob Gets Her Into Trouble, Why Divorce is More Expensive Than Marriage, and Hip, Hip, Hooray for Basecamp!

Sean RingSean Ring

Editor, Rude Awakening

 

Treasury Secretary Janet Yellen tells the world The Fed is in charge, inflation or not. Boomers, mathematically challenged at the best of times, pay up to leave. As Basecamp wants its employees to work instead of SJWing on the job, millennials collectively gasp.

Back to Basics: How Does the Fed Actually Control Rates

Before I get into what Madam Yellen said, let’s hammer out how the central bank of the United States, the Federal Reserve, attempts to, and usually successfully does, control interest rates. This isn’t wedded to any particular economic theory, but a practical translation of what the Fed and other central banks actually do.

If you feel the intense need to read academic papers, Mishkin (1995) is the one that sets the standard for this subject. But it’s not at all necessary to do so.

Keep one eye on this chart, as I talk you through it.

How Does the Fed Actually Control Rates

The Fed has kept rates on the floor for the best part of 13 years now. Here’s the thinking behind it.

The Official Rate – or the Federal Funds Target Range

As the Fed sees the economy slowing down (or crashing like in 2008), they will cut the official rate to stop the bleeding. Nowadays, that’s not the Federal Funds Target Rate, which the Fed did away with in 2008. It’s the Federal Funds Target Range. The range currently sits at 0.00% – 0.25%.

Why do they cut rates? Because if rates are lower, it incentivizes corporations, businesses, and consumers to borrow more, thereby kickstarting the economy.

Market Rates and Asset Prices

As a result of the rate cut, the rest of the market rates should follow. The prime rate, which is the best rate companies can borrow at, should also fall, as well as mortgage and credit card rates, in theory.

When market rates fall, asset prices should rise, as they have an inverse relationship, in theory. When assets such as stocks and houses increase in price, consumers feel good, lifting confidence and expectations.

Your Country’s Currency

At the same time, the spot exchange rate should fall. “Spot,” by the way, means “trade date + 2 settlement” in the foreign exchange market. When institutional investors sell, say, euro/dollar today (Wednesday), they will see the euros leave their account and the dollars enter their account in two days (Friday). Though there are exceptions, this is the international standard for most currency pairs.

Why would your currency decrease with respect to our currencies when rates are cut? Because international investors will seek higher deposit rates elsewhere. That is, they will sell your country’s currency to buy another, higher-yielding currency.

Domestic, External, and Total Demand

As rates fall, confidence increases, and asset prices rise, domestic demand should increase. And as the spot exchange rate falls, your country’s goods and services get cheaper, thereby increasing external or foreign demand for them. Hence, total demand increases.

Simultaneously, as your spot exchange rate falls, foreign goods become more expensive, raising import prices.

Et Voila, Inflation!

This creates the vaunted inflation central banks look for. Most central banks have a 2% annual inflation target. So, credit gets easier to obtain and goods and services get more expensive. And the bankers think this is good.

Here’s the chart again, with arrows denoting what I wrote, to make it easier for you:

How Does the Fed Actually Control Rates

She Said

And this is what makes Treasury Secretary Yellen’s words so incendiary. She really didn’t say all that much, but the market took it as reversing the very process we just went through.

“It may be that interest rates will have to rise somewhat to make sure that our economy doesn’t overheat, even though the additional spending is relatively small relative to the size of the economy,” she said in a prerecorded interview at the Atlantic’s Future Economy Summit.

Hawks and Doves

This makes complete sense to me, but the markets took it as a hawkish stance. (Hawish means you want rates to rise; dovish, rates to fall or remain accommodating.)

And here’s the danger: when you go from 0.25% to 0.50%, you’re not merely bumping them up by 0.25%, you’re doubling the rate. That’s the problem the Fed has starting from such a small base. But that’s the Fed’s fault, for cutting rates too low, to begin with.

It’s important to note when Secretary Yellen was Chairman of the Fed from 2014-2018, she raised the Fed Funds Target Range from 0.00% – 0.25% to 1.25% – 1.5%. Over that period, the S&P 500 rose about 1,000 points. Here’s that chart below.

S&P 500

As we move along, after February 2018, when Yellen left the Fed, we can see continued rate rises led to a sharp sell-off at the end of 2018 (orange box in the below chart). This is what’s probably spooking the market now.

When Jay Powell took over the Fed, he was as anxious as then-President Trump was to get rates back to normality (usually around 5%). But that wasn’t to be, as once rates got to 2.5%, the market puked.

S&P 500

That selloff has since haunted the Fed. So when Madam Yellen spoke up, the market jigged a bit.

She quickly walked back her comments by saying, “I don’t think there’s going to be an inflationary problem, but if there is, the Fed can be counted on to address it.”

I think the point is not Janet Yellen voicing an opinion. It’s that when an innocuous opinion is voiced, the market may take it more seriously than it deserves. And to me, that’s a sign of weakness.

If You Think Marriage is Expensive, Try Divorce

As we dry our eyes over Bill and Melinda Gates parting ways after 27 years of marriage, I remember the old Wall Street/City of London maxim:

If it flies, floats, or fornicates, it’s cheaper to rent.

Feel free to replace “fornicate” with a shorter “f-word” on your own time. I certainly can’t do that here!

No planes. No boats. No wives. There lies the road to riches.

For those of us who want families, however, marriage is a must (usually). And if you’ve been or are married, you know what it costs… even if you actively avoid the mathematical calculations for your own sanity’s sake.

I have friends who went through terrible divorces, and most would choose death rather than go through it again. (Note to self: clarify whether they mean “suicide” or “murder.”)

Now, baby boomer or “gray” divorces are surging, doubling since 1990. And it’s an expensive proposition.

Check out these frightening statistics:

  • 48% of households headed by someone 55 or older lack any kind of retirement savings.
  • The standard of living for a man divorcing after age 50 drops by 21%; women by a life-altering 45%.
  • 70% of unmarried persons depend on Social Security for 50% or more of their income.
  • 45% of unmarried persons depend on Social Security for 90% or more of their income.

So even if your spouse has a face like a camel chewing on burnt toast, think to yourself: can I afford to not look at it?

From a trader buddy of mine:

trader buddy of mine

And Finally, Three Cheers for Basecamp!

When my publisher, Chris, hired me, he said, “Awaken them… rudely.” Not make the world a better place. Or solve world peace. Or shoot rainbows out of my bottom.

I have no idea how these kids get a job and think, “I know they hired me to code, but I’m going to unilaterally change my job description.”

And with that, one of the best-run companies on earth, Basecamp, has offered severance for employees who can’t see themselves working for a company that wants to keep politics off the company’s servers.

Nice guys, methinks. I’d have sacked the lot of them.

You can read Basecamp CEO Jason Fried’s blog post about the situation here.

I’m rooting for you, Basecamp, as are a great many other people, even if they’re doing so quietly.

And with that, I hope you have a super Tuesday!

All the best,

Regards,

Sean Ring

Sean Ring
Editor, Rude Awakening

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