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There is No Exit From ZIRP For The Fed!

[The following post is from TDV’s Senior Analyst, Ed Bugos]

The cat is out of the bag.

CNBC asks, “Fed-in-a-box: Will there ever be a good time?”

With the economy slowing around the world Goldman Sachs has toned down its bullish rhetoric on the stock bull, holding out hope, however so objectively, that “Flat is the new up”. Concern about the economy has begun to mount too. And mainstream pundits have begun to realize that the Fed is stuck. It risks waking the inflation genie by keeping rates low for too long on the one hand, but it can’t raise rates with the threat of deflation looming on the other. From its point of view, price instability on the down low is just as bad as instability when prices are rising too fast.

The US central bank is trapped in its historic extreme cheap money policy because low inflation and full employment are not supposed to occur at the same time! For any normal person this would seem like a terrific thing. Unfortunately, it is an illusion. The only reason it exists is due to an abnormally low interest rate policy. However, in the Fed’s eyes, it’s just another phillips curve paradox. Only it is the opposite of stagflation. Instead of inflation and unemployment both being paradoxically high they are both paradoxically low! Or such was Yellen’s analysis last week, as she tried to build a case for keeping interest rates low even if unemployment fell below 4.9%.

In classic fedspeak such paradoxes limit what the central bank ‘can do’.

But right there lies a crucial problem.

Election commercials have exploded in recent months as Canadians are preparing to embark upon the polls to vote in their favorite lesser evils, and the race for who gets to be president of the collapsing empire of debt and fiat in 2016 has already started. The platform pleas all have the same theme: ‘pick me to “run” the economy.’ The thing is, that’s how the Fed got into a box.

In the most effective words of Rothbard, Boom / bust cycles are caused — not by the mysterious workings of the capitalist system — but by governmental interventions in that system

At TDV we have been trying to show you that central banks are not the bastions of stability and responsibility that they make themselves out to be. In our narrative, it is a taxpayer funded scheme that supports an unsound banking system and big fat government. Its true dual mandate is to help banks, brokers and cronies make money – by inflating asset prices – and to finance government expenditures and empire building agendas through the hidden tax of public debt.

It is a great burden on the actual economy.

By contrast, in a speech to the university of Massachusetts last week, Janet Yellen spent a lot of time giving the Fed credit for its ability to inspire the public’s confidence in its stewardship of the economy. In reviewing a history of Fed policy going back to the 1960’s, she took care to blame everything else for the break out in inflation that occurred in the 1970’s besides the true culprit.

Basically, in the Fed’s framework, food and energy price inflation are always temporary factors – they ebb and flow around a core inflation rate but evidently don’t influence it. The core rate of inflation itself deviates from a long run rate of inflation, which is determined by expectations, when it is influenced by “idiosyncratic” external shocks, economic growth, import price fluctuations, all of which influence underlying expectations, i.e., long run confidence in the Fed.

As Yellen said, while having a stroke or realizing she can’t keep this charade going much longer, “…to summarize this analysis suggests that economic slack, changes in imported goods prices, and idiosyncratic shocks all cause core inflation to deviate from a longer run trend that is ultimately determined by long run inflation expectations” 

But the source of the shocks, trends in import price inflation, and inflation generally is not really discussed, and curiously, neither are the impacts of changes in Fed policy or their interventions.

It’s as if through no fundamental influence of its own inflation just appears out of nowhere, just like those pesky migrants, maybe because the Fed has a bad PR department or something. Not one minute was spent discussing the expansion of money supply – the creation of money – or crowding out of savers.  In fact, we are one of the only financial newsletters that monitor this metric closely while the rest of the crowd mostly chases the latest trend.

Expanding the stock of money is after all where inflation ultimately comes from. You know it. We know it. Everyone knows it except the brainwashed sheeple who watch mainstream television programming and those who get their Economics degrees in Keynesian universities. But the Fed never discusses it. Yellen’s speech ended “abruptly” after almost an hour of trying to exculpate the Fed as the cause of either inflation or the boom / bust cycle, and justifying its post 2008 most inflationary monetary policy. She went into a loop and began to repeat things, incoherently; saying that besides slack in the labor market transitory factors are responsible for the low inflation, but that as these factors dissipate the Fed will start hiking rates gradually, unless econ conditions change and call for them to abandon that course.

She appeared to be trying to understand her own notes while in the loop, dragging out the long meaningless already oft repeated message, until deciding to end the talk.  Actually, aside from the choking and coughing it wasn’t altogether more vague and insipid than normal.  

yellen youtube dollar vigilante massachusettes stroke 2

With regard to what the Fed will do next, her message was as ambiguous as normal.

Based on present Fed forecasts, even after the recent rout in financial markets, they feel they need to start the rate hike campaign sooner than later. But her case was unconvincing as she qualified her reliance on the controversial phillips curve approach (which assumes that inflation and unemployment are inversely related), and made the case that external economic shocks may be cause to lower those forecasts, as well as the possibility of targeting a highly manipulated unemployment rate below the 4.9% historic norm for a short time – until the labor market is structurally healed.

Apparently it hasn’t recovered enough for even a quarter point increase, yet!

Barring some terrific news about the economy that would have to come out of left field at this point, if they don’t hike rates at the next meeting chances are they won’t hike them this year.

In terms of probability, most traders are betting there won’t be a rate hike now until after January.

This is bad news for the dollar but it hasn’t sunk in yet in the market.

I would be amazed if anyone really listened to her whole speech. I did. It revealed a Fed that is trying hard to spin itself out of a potentially dangerous psychological game with the market.

But it would have never gotten itself into this game if it weren’t for the need to manage the economy. I hate to sound repetitive but it is a line that is repeated several times a day on most business or economics news programs. Every analyst who comments about China comes out and agrees that its central bank should come to the economy’s rescue, like the Fed post ‘08.

It is surreal to think that anyone would actually expect these policies to produce growth.

They undermine growth by destroying savers, capital, and by promoting malinvestment.

It’s time to abolish these poisonous institutions before they finance another world war.

You have heard us say it a thousand times. But, now, you are finally hearing mainstream media sources puzzle over the Fed’s quagmire. Even if they haven’t quite got it right this marks the beginning of the downward spiral in false confidence that the Fed has built on a house of cards.

As free marketeers we wished people would at last see that manipulating money supply and interest rates is just another form of economic planning, and subject to the “fatal conceit.”

It has encouraged excessive debts and insolvency among world governments, and has imposed a boom-bust cycle on the free market economy – hampering its true engine of growth.

In the final analysis, this mindset is going to lead us into a hyperinflationary quagmire.

That’s why we started this newsletter in 2010. We saw this day coming. Prepare yourself. The planners are stuck in a paradox and they only know one way out of it. To print like no tomorrow.

Subscribe to our newsletter to stay up to date on our recommended investment strategy, trading ideas, and gold stock picks. The precious metals are still weak but precious metals equities are another matter altogether. The bear market in gold stocks has left unbelievable bargains, and I have spent my time separating the wheat from the chaff to put together a portfolio of gold stocks that will outperform the average gold stock index during the next stage of the precious metals bull market.

Don’t miss out, start buying them now… not as a matter of bottom picking, but value investing.

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Ed Bugos

Mr. Bugos is the Dollar Vigilante's Senior Analyst and founding partner. He is an Austrian economist and has been a dedicated investment professional since 1989, having started his career as a stock and futures broker on Howe Street at one of Vancouver's leading brokerage firms. Ed retired in 2000 warning clients about the tech bubble, and launched an online digest forecasting gold's revival and bull market when it was just $285. He saw the value in bitcoin as a potentially sounder alternative to the present fiat currency system as early as 2011 before many of his Austrian peers. Ed has built a career record of being early on major economic trends, bullish and bearish.
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