The Fed And Its Muddy Path Forward (We Live In Unusual Times And We Should Expect Conditions Around Us To Be Both Unpredictable And Volatile.)
Not forcing the government to cut spending and allowing it to pile up massive debt can be seen as the Fed's biggest failure. The existing massive sovereign debt makes the Fed's path forward a matter of great debate. When describing its options, terms such as "painted itself in a corner" are used. This indicates many people understand the Fed is not limited in its options but will face great difficulty in arriving at a good outcome.
Insanity and madness in the financial system and politics have reached the point where it has become normal. This is evident in many areas of our society. Little noticed was Jill Biden recently running a cabinet meeting like this was a normal part of the First Lady's role in Washington. This comes at the same time assassination attempts on Trump, a Presidential candidate and former President, are seen as no big deal. These dovetail with claims we need an interest rate cut when markets are making new highs.
With equities, gold, and many other markets hitting all-time highs, the Fed cut rates 50 basis points. How do we reconcile the idea we must rapidly cut rates if the economy is doing so well?
Circling back to economics, around six minutes into a recent video, Daniel Lacalle, author and professor of economics, mentions the unmentionable, unfunded liabilities. He also makes it clear that America is not alone or positioned as poorly as many other countries. Laccalle then moves into an in-depth discussion on shifts now occurring. Lacalle also covers much of the unfunded liabilities in a much shorter six-minute video that points to the debasement of currencies and more loss of purchasing power in the future.
Very troubling is his case that we have seen nothing yet. Lacalle claims we are on a course of “monetary destruction” that will get far worse as we move towards the 2030s. This has created a situation where some investors are already moving towards strategies that safeguard their wealth in uncertain times. This includes things such as negative interest rates, bank bail-ins, and the topic of de-dollarisation. Financial repression is not implemented to give us choices but is a tool to shift wealth away from the people and to the government.
As already noted, the Fed is not alone, central banks across the world have miserably failed to contain government expansion and spending. In the minds of many investors, it is odd that the price of Gold going higher at the same time many economic pundits talk about falling into a deflationary recession or worse. If gold and dollars rise together this is of course in relation to all other fiat currencies. Still, there is the problem that as the dollar rises in relationship to other currencies it creates havoc in global markets.
The fact is, much of the power of central banks flows from being able to inject liquidity into the market during times of turmoil. Their Achilles heal or weakness, which many people have yet to understand, is their limited ability to control the long end of the rate curve. This refers to long-term interest rates, these rates are more dependent on investors' sentiment and views of currency debasement and inflation.
The recent volatility blamed on an unwinding of the Japanese carry trade highlights how the relationship in the value of fiat currencies can pack a wallop. Even as this is being written, we have economists and economic advisers pointing in all directions when it comes to where markets are going. Some are predicting a melt-up, some are declaring "clear skies ahead," and others that the economic wheels are about to fall off the bus.
When it comes to those controlling the Central Banks making decisions that determine the course we take, it would be wise to remember they do not have total control of the situation. We may find they chose the wrong course, their tricks, or even changing the rules are ineffective. In a past posting, I pointed out that given enough pressure they might, even if it is a bad decision, again open the gates and flood the system with a plentiful supply of cheap money.
We should marvel at how far Fedspeak, wordy, vague, and ambiguous statements, has gotten us so far. This is amazing considering how broken and dysfunctional the financial system has become. The crux of this post is that we live in unusual times and we should expect conditions around us to be both unpredictable and volatile. Factor in the coming election, the drumbeat of war, and what is happening in the area hit by Hurricane Helene, and it is clear, that we live in interesting times. With this in mind, it is difficult to envision the Fed will be able to continue successfully threading the needle.
Fed's Interest Rate Cuts May Not Bring Strong Economy
As the Fed begins to cut interest rates, it is important to consider the possibility that lower rates will not produce a stronger economy. We only need to look at Japan to see the proof an economy is about far more than just interest rates. Feeding into this is the Fed's limited ability to directly determine rates at the long end of the curve.
Lower rates have almost been guaranteed and promised, however, we should never forget that liquidity is far more important. This is why a past article here on AdvancingTime touted the idea more focus should be placed on liquidity rather than interest rates. When you need money, whether the amount is small or large, not being able to get it can lead to a life-changing or grave outcome. Yes, it is possible rates can fall at the same time credit tightens. This can result in dire consequences.
Contagion is a word used to describe how a disease is passed from one individual to another. It is also used to explain how problems in one area of the economy tend to spill over into other sectors of the economy and markets. When it does it can occur quickly and be devastating to the financial system. This is why it would be wise to remember that if you have good credit you will always be able to get a loan a myth.
People learn in a credit crunch that liquidity is far more important than interest rates. Many years of an easy credit environment have numbed people to the reality that credit is not a guaranteed right. This is a reality that can hit us like a slap in the face.
Part of what we will see in the coming months could be simply an adjustment in the flow of capital to those who want it most or can afford it. Much of what may develop is a lack of willingness to lend based on the possibility the risk of not being repaid increases in a difficult economy. This has the potential to create a self-feeding loop in a credit-tightening cycle. Halting such a damaging loop can come down to the Fed's questionable ability to get banks to lend during adverse conditions.
The notion you stand a snowball's chance in hell of getting a loan in an environment of credit tightening has yet to dawn on many people. The existence of so-called "loan sharks" underlines the idea that if someone is desperate to borrow money they will often put themselves in danger to do so. Loan sharks, which generally operate outside the law, offer loans at extremely high interest rates and have strict terms of collection if the loan is not repaid.
Most people have not experienced cycles of severe credit tightening and may have difficulty imagining such a scenario. This is partially due to what may be considered "memory bias" or "recency bias." This can result in confusion as new situations arise. Memories tend to be clouded by people incorrectly believing that recent events will likely occur again. This tendency obscures the probability the future may be quite different from the past and leads people to make poor decisions based on the recent past.
Like many businesses, the banking sector has changed over the years. The banking industry is far different than it was a few decades ago. As a financial institution, banks are licensed to accept deposits and make loans. Not only do banks protect our money, they lend out this money to create profits. But they also perform a lot of other financial services. That said, banks are not shy about placing upon customers a lot of fees and other charges.
- The three main business segments for a bank are retail banking, wholesale banking, and wealth management.
- Retail banking or personal banking involves deposits, mortgages, loans, and credit cards.
- Wholesale banking is related to sales and trading and mergers and acquisitions.
- Wealth management generates revenue through retail brokerage services and asset management.
The simple and ugly truth is banks are not "good neighbors" there to serve and be concerned about the community. Banks do not make much money on small loans at low-interest rates. The cost of making these loans far outweighs the income flowing from them even before factoring in the risk of default. This is why most small businesses must turn to other sources in order to find financing and a lot of these are loans "hidden off the balance sheet" at much higher rates. When push comes to shove, the banks will be fast to throw you under the bus. Adding insult to injury, if you have put assets up with them as collateral, they may be inclined to seize them if doing so plays to their advantage.
Liquidity is the lifeblood of commerce. The massive growth in the financial sector versus Main Street, the GDP, and the real economy has made debt a major concern. Credit markets will be coming under a lot of pressure as a great deal of this debt coming due. Adding to the problem is that much of it is short-term debt that must be rolled over or extended. It will be interesting how this plays out in a "risk off" environment. It is just one of the factors helping to determine where investors park their wealth and in what form.
Lately, the Fed has been boxed in by the hyper-reaction of investors to anything it does. It needs to get investors to refocus on profits, margins, and risk. The combination of cheap money, and too much of it, has fueled speculation and blown the lid off markets in recent years. It seems that greed has overshadowed the degree a tightening in credit standards can impact the economy. This is partially due to either the Fed's or the government's willingness to generate stimulus that promotes the wealth effect.
The growth generated from low-interest rates and easy credit has some drawbacks. This takes us to the issue of where the stimulus is coming from. Consider that stimulating the economy through monetary policy and stimulus from fiscal spending have different long-term implications for inflation. It also impacts the economy in a big way, especially when it is not geared towards increasing productivity.
This has fostered an environment where the stock market has been less efficient in discovering the true value of companies. While recessions halt inflation the issue is just how much irreparable damage it will inflict on Main Street and society as the "lag effect" hits us in the face. The stock market is not cheap, earnings will most likely fall takeing stock prices with them. In response, expect tapped-out consumers to cut back on spending, unemployment to rise, and a lot of small businesses to fail.
A lack of liquidity can be poisonous. When you need money, whether the amount is small or large, not being able to get it can lead to a life-changing or grave outcome. It is important to point out that housing values are a far bigger issue for most Americans than stocks. Still, these markets do influence each other. Dealing with a "bubble economy" is always a problem and results in investors and people, in general, to buy high and sell low, often with devastating consequences.
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