AP YELLEN A F USA DC

This blog spends a lot of time covering foreign policy, terrorist organizations, and the threat they pose to national security, but one can certainly make the argument that the Federal Reserve is much more of a danger to the long-term health of the nation. These days I typically leave it to others to talk about the implications of printing dollars as if they were Monopoly money, addictions to artificially-low interest rates, and the use of inflation-as-stealth-taxation. However, Federal Reserve chairman Janet Yellen spoke earlier in the week, and it deserves mention.

The Associated Press reported Sept. 18:

Record-low interest rates will be around for at least a few more months, the Federal Reserve made clear Wednesday. Enjoy the easy money while it lasts.

By mid-2015, economists expect the Fed to abandon a nearly 6-year-old policy of keeping short-term rates at record lows. Those rates have helped support the economy, cheered the stock market and shrunk mortgage rates. A Fed rate increase could potentially reverse those trends. …

“Borrowers should see the writing on the wall,” said Greg McBride, chief financial analyst at Bankrate.com. …

Investors, in particular, might recall that mere speculation about the end of the Fed’s stimulus shook global financial markets in May 2013. In coming months, as the prospect of higher rates nears, traders might once again dump stocks and bonds and send prices tumbling.

The Jenga Economy will eventually tumble and fall on the heads of retired people, young people, and a whole host of Americans whose lives will be turned upside down when the “easy money” ends.

Former Office of Management and Budget Director David Stockman sat down with Yahoo Finance Sept. 17 and said the following about the Federal Reserve:

David Stockman: I’m worried that we’ve got the greatest bubble created by a central bank in human history. We have been shoving zero-cost money into the financial markets for six years running. This is the 68th month of zero-money market rates. We’ll that’s the kerosene that drives speculative trading. The carry trades. That’s what the gamblers use to fund their position as they move from one momentum play and trade to another. So we have basically created — the fed has created — the bubble, which is unsustainable. Everything is massively overvalued and it’s predicated on zero-cost overnight money that continues these carry trades. You can’t continue. And so, when the trades begin to unwind because the carry-cost has to normalize, you’re going to have a dramatic repricing and dislocations in these financial markets, but especially in tech.

Host: So let me ask you why investors should care now, because looking back — you know, I went back and looked at one of the last times we spoke — when you were promoting your book and you had just written a New York Times op-ed on March 30th of last year. The stock market was hitting all-time highs, and you said “Instead of cheering, we should be very afraid. If this sounds like advice to get out of the markets and hide in cash, it is.” Well, the market is up 28 percent since then, David. If people took your advice, then they missed out on gains.

David Stockman: Well look it, it’s not over until it’s over. And if people think they’re smart enough to play it by the day and trade it by the hour and compete with all of these robotic trading systems that are driving the market, then more power to them. But no one can predict when the break is going to come, when black swan is going to arrive, but when it does there will be a sharp, violent and rapid repricing. Adjustment. And so the 28 percent can disappear as fast as it appeared. […] I think what the fed is doing is so unprecedented. What is happening in the markets is so unnatural. There has been so much liquidity — and you can give all the figures — almost $4 trillion dollars has been pumped into the market in less than 70 months by this central bank and has matched by central banks all over the world — this is dangerous, combustible stuff. And I don’t know when the explosion occurs. When the collapse suddenly is upon us, but when it happens, people will be happy that they got out of the way if they did.”

Most Americans don’t speak the language of Yahoo Finance hosts, Janet Yellen or David Stockman, so I asked a well-adjusted friend of mine to explain things in a way that normal Americans can understand.

Here was his reply:

I think the govt has used every trick in the book to keep wages high and the market high. The reason we have a 30 year trade imbalance is because wages didn’t come down to meet world demand, plus unemployment, it’s a real mess. The trade imbalance occurs because all his money is pumped into the economy, income is high though we produce little; and we buy extra stuff from outside sources. Now we are trillions in debt and the economy won’t grow out of it like years past (anytime soon).

Unfortunately we have to bite it at some point and either let the dollar devalue or interest rates rise, getting our short term supply an demand curves back from artificial highs. It won’t be pretty. China keeps their currency purposefully low, that’s why people keep manufacturing there…. Hmmm, I remember Romney mentioning that and being blown off. I’d imagine they are creating some sort of bubble too.

The “normal” growth rate for our economy is roughly 3 percent, when recession hits it obviously must grow more than 3 percent to get us back to the “normal” trajectory. That hasn’t happened this time around. We stopped recessing, but we aren’t back to the desired trajectory, hence unemployment still high. So pray for a natural resource boon or some dramatic new technology to save us.

Oddly, only one president in our lifetime saw and did something about the writing on the wall, that being the first George Bush. He went against his promise and raised taxes to get the debt to a manageable percentage to GDP and to alleviate the artificial highs I spoke of. Of course that led to a split in the party, and he was vilified. Obama really was stuck in a bad boat in 2008, and in his defense it was typical government response to a threatening depression. However, due to 30+ years of a “free ride” we can’t recover fast enough to lower the debt percentage. We really have ourselves to blame from both parties.

Now you have the baby boomers wanting to retire further stressing things… Get ready for a bumpy ride!

Get ready for a bumpy ride, indeed. While it’s important to pay attention to radical Islamic terror groups, it’s also important to remember that there are many ways a nation can lose its head.

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About the Author Douglas Ernst

I'm a former Army guy who believes success comes through hard work, honesty, optimism, and perseverance. I believe seeing yourself as a victim creates a self-fulfilling prophecy. I believe in God. I'm a USC Trojan with an MA in Political Science from American University.

2 comments

  1. Interestingly, if I’m reading Keynesian theory correctly; he did advocate govt intervention when things are in a down cycle; but also thought govt should pull back when things cycle upward…..our government never took foot off the pedal.

  2. I have been saying for years that the underdeveloped countries need to build up and we will need to see our standard of living decline in order to have more competitive competition (or we need to build the other countries up fast). I would call this growing pain, since the goal will be for us to get past the tough time then when we have made the population grow that can buy from us we can excel again. I look at this as if we are planting crops, when the other countries increase to a closer level to us we will be competitive again.
    We need to have a society that produces rather than mooches. We still believe in taking care of each other but we are built on a theory of more productivity. We need to produce before we can provide help and the numbers are moving in a negative way.

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