The Precarious Fed

27 Feb
Federal Reserve Eagle

The Precarious Fed

Gold Market Discussion

Do You Really Think This Can End Well?

We do occasionally run into someone who doesn’t understand our beef with the Federal Reserve.

You would think having destroyed 96 percent of the dollar’s purchasing power since it  went into business in 1913 would be reason enough to be dissatisfied with the Fed.  Not to mention engineering the worst economic upheavals in the country’s history, events like the Great Recession and Housing Bust, the Inflation Crack-Up and double-digit interest rates of the 1970s, or the Great Depression.

For those who don’t see the hand of the Fed behind those calamities, we can only point to the Fed’s serial stock market bubbles and ask, “Do you really think this can end well?”

By “this” we mean the Fed’s slavish relationship to Wall Street and the money center banks.

To illustrate the precariousness of it all, we have attached a chart overlaying the Fed’s interest rate suppression of almost forty years (the brown line) with the heights to which  it has driven the stock market (the blue line) represented by the Wilshire 5000 Total Market Index.

Having created the double-digit interest rates of the 70s, the Stagflation Decade, the Fed engineered the record high rates seen on the left-hand side of the chart beginning in the early 80s.  It has spent the following decades driving interest rates down.  Along the way the Fed has made its role as the handmaiden of Wall Street explicit.  You can see the result:  artificially low rates have made borrowing cheap and provided a major subsidy for Wall Street.

Look carefully at the decades of falling rates.  Down, down, down.  Year after year of interest rate suppression.  The Greenspan Fed.  The Bernanke Fed.  The Yellen Fed.  

And when the current Fed chairman, a fellow named Powell, thought he would change things, he was handed his lunch.  In a prior post, we noted the speed with which Wall Street was able reverse even a modest effort by the Fed to normalize interest rates.  

Wall Street’s temper tantrum, The December collapse of stock prices, drew a quicker response than the government shut down.  

The Fed’s about-face was total.  “Raise rates?  Why, no sir.  Never had any such thing mind.”

So, for all the aforementioned Fed calamities, this stock bubble promises to be the biggest and baddest of them all.

For the last decade or so, real interest rates (the nominal interest rate minus the inflation rate) have been bumping along near zero.  Wall Street has loved it.  But now ask yourself, if it takes constantly lower interest rates to sustain the stock market, how much lower can rates go?

Not only is the answer not much, but all the economic fundamentals militate for higher rates.  To provide one example, observe the growing revolt against America’s international sanctions regimes.  Foreign countries have discovered they don’t like being told where they can buy the energy they need to keep warm in the winter, or who they may or may not sell their goods to.  And they don’t want their dollar accounts frozen by Washington bureaucrats.  Already foreign buyers presence in the US Treasury market is described as “fading.” Their search for alternatives to dollar jeopardy eventually will mean the US will have to offer higher rates to sell its debt instruments.

What we are saying is simply this:  The stock market is a bubble of enormous proportions.  The Fed will try to keep it inflated, but eventually it will fail.  Eventually rates will rise.

And as always, the bigger the bubble, the bigger the bust.

That’s just one reason why you should own gold.