Transitory, Like Tectonic Plates

Happy Friday!

We’re finally here, thank heavens.

My class ends today, and I can just concentrate on writing for the next few weeks.  I always send my invoice on the morning of my last day of class to give me an extra boost.

Well, it looks like I was right about the Fed – as you indeed were, too.

They’re not genuinely in control, if they ever were.

Rumble in the Jungle

Not long ago, I was lying in bed in the early hours of the morning when I felt the bed moving.

I thought to myself, “Gee, Mrs. Ring, it’s been a while…”

As I awoke from this dreamy state, I looked up.

Alas, Mrs. Ring wasn’t on the bouncy castle.  The whole house was shaking.  It was an earthquake.

The quake’s epicenter was over 100 miles away, but we felt it.

The funny thing about tectonic plates is that they move all the time.  All day, every day.

But every once in a while, they move so violently that the earth shakes beneath one’s feet, and it’s time to take cover.

I’m not saying that time is right now.

But it’s coming, as surely as night follows the day.

Why?  Because Jay Powell is following the script that always leads to collapse.

They Called It Decades Ago

Ludwig von Mises, in his Theory of Money and Credit, wrote this:

The people of all countries agree that the present state of monetary affairs is unsatisfactory and that a change is highly desirable… The destruction of the monetary order was the result of deliberate actions on the part of various governments. The government-controlled central banks and, in the United States, the government-controlled Federal Reserve System were the instruments applied in this process of disorganization and demolition. Yet without exception, all drafts for an improvement of currency systems assign to the governments unrestricted supremacy in matters of currency and design fantastic images of superprivileged superbanks… The inanity of all these plans is not accidental. It is the logical outcome of the social philosophy of their authors.

Sounds recent, doesn’t it?  Mises wrote that in his 1952 edition.

“There are two kinds of forecasters: those who don’t know, and those who don’t know they don’t know.”

― John Kenneth Galbraith

My goodness, do these bureaucrats ever get anything right?

You may remember when I wrote earlier this year the Fed’s call that “inflation is transitory” was complete nonsense.

I didn’t buy it for a second.

One of the things that many brilliant economists before me have said is that central banks lose control of interest rates eventually.

Of course, the Fed was wrong. Inflation is not transitory.

I had a good chuckle as I thumbed through my Wall Street Journal yesterday, reading about it. 

In his article, Greg Ip, the ubiquitous Fed watcher, wrote that six of 18 Fed governors on the FOMC believe that core inflation will run hotter than 2.5% for the next year.

This is not good for the consumer. Stuff has been getting more expensive and will continue to get more expensive.

Murray Rothbard masterfully wrote in his magnum opus, Man, Economy, and State:

Credit expansion always generates the business cycle process, even when other tendencies cloak its workings. Thus, many people believe that all is well if prices do not rise or if the actually recorded interest rate does not fall. But prices may well not rise because of some counteracting force—such as an increase in the supply of goods or a rise in the demand for money. But this does not mean that the boom-depression cycle fails to occur.

The essential processes of the boom—distorted interest rates, malinvestments, bankruptcies, etc.—continue unchecked. This is one of the reasons why those who approach business cycles from a statistical point of view and try in that way to arrive at a theory are in hopeless error. Any historical-statistical fact is a complex resultant of many causal influences and cannot be used as a simple element with which to construct a causal theory.

The point is that credit expansion raises prices beyond what they would have been in the free market and thereby creates the business cycle. Similarly, credit expansion does not necessarily lower the interest rate below the rate previously recorded; it lowers the rate below what it would have been in the free market and thus creates distortion and malinvestment. Recorded interest rates in the boom will generally rise, in fact, because of the purchasing-power component in the market interest rate.

An increase in prices, as we have seen, generates a positive purchasing-power component in the natural interest rate, i.e., the rate of return earned by businessmen on the market. In the free market, this would quickly be reflected in the loan rate, which, as we have seen above, is completely dependent on the natural rate. But a continual influx of circulating credit prevents the loan rate from catching up with the natural rate, and thereby generates the business-cycle process.

John Maynard Keynes wrote about animal spirits, and I think he’s right, too.  But only after a load of free money is printed.

And let’s face it, the world is full of animals right now.

So what’s happening is this. We are seeing an excess of loanable funds around the world that are driving up asset prices. And this does not look set to end anytime soon, couple that with our supply chain problems, and you’ve got a massive plate set for a price increase.

Here Comes Another Taper Tantrum

The Fed wants to taper its bond purchases, which currently run at $120 billion a month before it starts to raise rates again. I think that’s smart, but I think they’re rushing things.

Here’s how I would do it. I would taper the bond purchases to zero as they plan to do. I would do that over a more extended period because the market cannot simultaneously take the sudden tapering of purchases plus an increase in interest rates. I’d stretch out the period to about five years.  Yes, I’d make it that long.

The tapering acts as a raise rise anyway, as the Fed is pulling money from the market.

Once that’s done, I would increase rates very gently by 50 basis points every 18 months. And yes, it would take an enormous amount of time for rates to get back to 5% if we did it every 18 months, but that’s the kind of drip-feed you need in market conditions like this.

This diagram is from the Bank of England. I redid this chart from their old website.

According to them, from the time the Bank of England raises rates to a decrease (in this case) in total demand takes 18 to 24 months.

From that decrease of demand to lowering inflation is another 18 to 24 months.

So, all in all, every rate hike needs at least 36 months to have the full effect.

Why then does the Fed raise rates a quarter of a point every meeting?

It wants to be seen to be doing something. That’s why.

Those little rate hikes don’t have time to settle in and affect anything before the next one comes in.

This is what creates the conditions for bubbles to pop… and pop they do.

If you recall, back at the end of 2018, when Donald Trump was president, Jay Powell tried this once before, and the market fell 20% in three months.

It wasn’t until Trump intervened directly and said, “I think it’s a great time to buy stocks,” on Christmas Eve that the market started to bounce back and had a V-shaped recovery.

Powell and his crew abandoned the hiking cycle.

Because of the Fed‘s ridiculously loose monetary policy, we are teetering on the brink.

The Economic Consequences

We talked about Evergreen yesterday. And like I said, I’m sure that many people are almost cheering for them to crash because then we could blame the whole darn thing on China. 

But the fact is if we had managed our monetary policy more prudently; if we had let more companies and banks go bankrupt in 2008 as we should have; if we slowly got our interest rates back to 5%, we really wouldn’t even be in this situation right now.

Savers would be earning a decent amount of just having their money in the bank.

The stock market wouldn’t be so frothy because Mom and Pop would keep their money in the bank instead of chasing yield.

Maybe we wouldn’t need a crypto craze.

Because let’s face it, those Bitcoiner people have a great point. In the genesis block of Bitcoin, there is a headline from The Times of London.

The whole reason that Satoshi Nakamoto, whoever he is, designed Bitcoin was to get money out of the clutches of governments and central banks.

He’s got a point, let’s face it.

So did Mises.  So did Rothbard.

So let’s see how this plays out.

Have a wonderful weekend!

All the best,

Sean

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