Big Policies, Bigger Failures

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.

By: 

Peter Schiff

Friday, August 19, 2016

Economics is far simpler than most in academics or government would have you believe. To make accurate predictions all you really need is an honest appreciation of the self-interest that is at the heart of free market transactions and an ability to understand how regulations that attempt to “correct” these realities don’t work. This is certainly the case with the completely predictable slow-motion train wrecks that are the signature U.S. domestic policy experiments of the last eight years: Obamacare and Federal Reserve stimulus. From the start, I issued countless commentaries on why both would fail spectacularly. The jury has started to come back on Obamacare, and the results are a disaster. And while the verdict on the Fed’s policies has yet to arrive in similarly stark terms, I believe that its failure is just as certain. 
 
As I explained in my July 30, 2012 commentary “Justice Roberts is Right: The Plan Won’t Work,” the central flaw (among many others) in Obamacare is that it incentivizes younger, healthier people to drop out of insurance coverage while encouraging older, sicker people to sign up. The result would be a pool of insurance participants that would guarantee losses for those providing coverage. That’s exactly what we are seeing.
 
After only four years of operation, there is now wholesale defection by insurance companies to abandon the Obamacare marketplace because they are hemorrhaging money faster than just about anyone predicted. To believe that any other outcome was possible would have been the equivalent of believing in the Tooth Fairy.
 
According to the Wall Street Journal, the four biggest U.S. health insurance companies, Anthem, Aetna, UnitedHealth and Humana are losing hundreds of millions of dollars on their Obamacare plans. And since these companies can’t be compelled to operate a business that loses money, all four have significantly scaled back their offerings. UnitedHealth has already exited 31 of the 34 states where it sells ACA policies. Humana is now offering coverage in just 156 counties of the 1,351 counties in which it was active a year ago. The latest shoe to drop came this week when Aetna said it would stop selling Obamacare plans in 11 of the 15 states where it is currently active (Bloomberg Businesweek, 8/17/16).
 
It’s no secret why the companies are losing so much money. Enrollees into the new plans take out far more money in benefits than they pay in premiums, despite the fact that premiums have increased substantially. That’s because the pool of insures in the Obamacare plans differ sharply from those that exist in the private marketplace. Why this has happened should have been stunningly obvious to anyone. To quote from my 2012 commentary:
 
“…the ACA makes it illegal for insurance providers to deny coverage to anyone for any reason. This allows healthy people to drop insurance until they actually need it without incurring any risk. It's like allowing homeowners to buy fire insurance after their houses burn down.” Given the high cost of insurance, the law allowed millions to take a free ride.
 
I argued then that penalties that would hit those who remained uninsured were insufficient to compel them to make an uneconomic decision. This was the same rational that was used by Chief Justice Roberts when he ruled that the plan was constitutional. He argued that since the penalties were not high enough to compel behavior, they should be seen as constitutional “taxes,” not unconstitutional “penalties.”
 
Similarly, by guaranteeing that no one could be denied insurance for any reason, and that the sick would pay the same premiums as the healthy, the plans have sucked in lots of people guaranteed to take out more in benefits than they pay in premiums. Add these factors together and you get the recipe for guaranteed losses. In retrospect, it is simply incredible that supposedly smart people argued against this outcome while the law was being drafted and passed.
 
At this rate, there may essentially be no private companies offering insurance through the exchanges within a few years. This will mean that unless president Clinton (Trump has promised to repeal Obamacare) passes a new law requiring companies to lose money for the good of the country (not too outlandish a possibility), or if the Supreme Court allows massive increases in the penalties for not buying insurance (thereby creating the coercive force that Justice Roberts argued was absent in the original law), then the government itself will have to step in and absorb the losses that are currently hitting the private insurers. At that point, Obamacare will become just what its critics always thought it was: an enormous new unfunded and open-ended government entitlement. 
 
While the flaws of Obamacare were incredibly easy to see, so too are the flaws in the Federal Reserve’s stimulus policy. What’s amazing to me is that more people aren’t able to see through it as easily.
 
Although few realized it while it was occurring, everyone now sees that the dotcom mania of the late 1990’s was a bubble that had to end badly. Most also realize now, as they didn’t realize then, that the housing bubble of the early years of the 21st Century (which took us out of the 2001 Recession) was a bubble created by the Federal Reserve’s unprecedented low interest rates in those years.  
 
But while we have gotten better at recognizing bubbles after they have burst, we are still totally blind to the ones that are currently forming. Ever since the Recession of 2008, the Federal Reserve has held interest rates at zero and has injected trillions of dollars into the financial markets through its quantitative easing policies. These moves have clearly inflated prices in the bond, stock, and real estate markets, an outcome that was an expressed aim of the policies.There is also clear evidence that these asset prices will come under intense pressure if interest rates were allowed to rise.
 
Recent history confirms this. Back in January of this year, just a few weeks after the Federal Reserve delivered the first rate increase in nearly a decade, the stock market entered a free fall. We had the worst opening two weeks of the calendar year in stock market history. The bleeding stopped only when the Fed backed off significantly from its prior rate hike projections. Since then, the market action has been clear to see: stocks rally when they believe the Fed will keep rates low, and then fall when they think they will rise. And so the Fed has played a continuous game of footsy with the market…forever hinting that hikes are possible but never actually raising them.
 
But given how close the economy could be trending toward recession, can anyone seriously believe that the Fed will risk kicking a potential recession into high gear by actually delivering another rate increase? It should be clear that it won’t, but somehow the best and brightest on Wall Street appear convinced that it will. Perhaps this explains why hedge funds have so consistently underperformed the market thus far in 2016.
 
To me, the fate of the Fed's stimulus policy is as clear as that of President Obama's failed experiment in healthcare. It's a disaster hiding in plain sight. The stimulus itself has so crippled the U.S. economy that it can now barely survive without it. As it limps along the crutch must grow ever larger, as the support it provides weakens the economy to the point where it becomes too small to provide adequate support. But rather than acknowledging that the Fed's policies have failed (an admission that any honest proponent of Obamacare should make), the proponents of stimulus are doubling down.
 
Earlier this week, John Williams, the president of the San Francisco Fed and widely believed to be a close confidant of Chairwoman Janet Yellen, issued an economic letter on the FRBSF website that lays the foundation for much greater stimulus for years to come. The centerpiece of Williams’ suggestions is that he would like to see the Fed raise its inflation target past the current 2%, and that the government be prepared to run much larger deficits to combat persistent economic weakness. In other words, ramp up the dosage of the medicine we have been taking for years, even though that medicine hasn’t worked. This shows a stunning inability to recognize a failed policy when it is staring at them in the face.
 
Absent from his analysis is any understanding that the stimulus policies of the past two decades may have actually created the conditions that have locked our economy into a perpetually weakened state. By preventing needed contractions, debt reductions, investment re-allocations and rebalancing, perennial stimulus has frozen in place a listless economy dependent on monetary support just to tread water. Just as Federal tax policy and healthcare regulations raised the costs of healthcare to the point where another bold (and ultimately futile) regulatory framework was launched to solve the problem, new forms of stimulus are being conjured to fix problems created by prior stimulants. But since Williams does not realize the stimulus he and his fellow quacks at the Fed have prescribed actually acts as a sedative, he has misdiagnosed the resulting condition of slower economic and productivity growth and as being the new normal.
 
Proof of this circular logic is Williams expressed desire to use monetary policy to push up “nominal GDP,” which is simply the GDP figures that are not adjusted for inflation. What good will it do for the average citizen if we get a higher GDP number that results merely from rising prices rather than actual economic growth? While the stimulus crowd likes to suggest that rising prices are a required ingredient for real growth because they encourage people to go out and spend before prices rise further, their asinine theory is completely unfounded. The entire purpose of deflating nominal GDP is to separate actual growth from rising prices. Pretending the economy is growing by targeting nominal GDP will only stifle real economic growth that might actually solve the problems the Fed still has no idea it created.
 
It is somewhat heartening that there is a greater recognition now of the inherent flaws in Obamacare. Hopefully such realizations will soon be widely raised about our current stimulus experiments, and that these insights will arrive in time to change course. However, confidence should be extremely low on that front.

To me, the fate of the Fed's stimulus policy is as clear as that of President Obama's failed experiment in healthcare. It's a disaster hiding in plain sight.  The stimulus itself has so crippled the U.S. economy that it can now barely survive without it.   As it limps along the crutch must grow ever larger, as the support it provides weakens the economy to the point where it becomes too small to provide adequate support.  But rather than acknowledging that the Fed's policies have failed (an admission that any honest proponent of Obamacare should make), the proponents of stimulus are doubling down.

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Source: Commentaries By Peter Schiff

Central Banks Are Choking Productivity

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.

By: 

Peter Schiff

Friday, August 12, 2016

If the Economy were a car, productivity would be the engine. Heated seats, on-demand 4-wheel drive and light-sensitive tinted windshields, are all very nice. But they mean little if the engine doesn’t turn and the car just sits in the driveway. The latest productivity data from the Commerce Department confirms that our economic engine is sputtering.
 
If you strip away all the bells and whistles of economic analysis, the simple truth is that the increased living standards that have taken us from the stone age to the digital age happened because we increased our productivity. Better plows, windmills, bulldozers, factories and, more recently, better software, technology and automation, have allowed economies to produce more output with less human effort. This means there are more goods and services for more people to share and workers can work less to acquire those goodies. When productivity stops increasing, no amount of financial gimmickry can compensate.
 
With this in mind the latest batch of productivity data should have significantly changed the conversation. But like other pieces of evidence that point to a weakening economy, the news made scarcely a ripple. The fact that few opinions about our economic health changed as a result, confirms just how big our blinders have become.
 
Most of the economic prognosticators were fairly confident about the Second Quarter numbers. After all, productivity had unexpectedly declined for the prior two quarters, and given the optimism that is ingrained on Wall Street and Washington, a big snap back was expected. The consensus was for an increase of .5%. Instead we got a .5% contraction. That’s a huge miss. The contraction resulted in three consecutive declines, something that hasn’t happened since the late 1970’s, an era often referred to as the “Malaise Days” of the Carter presidency. That time, which spawned such concepts as “stagflation” and “the misery index,” was widely regarded as one of the low points of U.S. economic history. Well, break out your roller disco skates, everything old is new again.
 
But it gets worse. Productivity declined by .4% from a year earlier, marking the first annual decline in three years. According to data from the Bureau of Labor Statistics, the total magnitude of the three quarter drop was the largest decline in productivity since 1993. The last three quarters mark a significant decline from the already abysmal productivity growth we have since the Financial Crisis of 2008. According to the Wall Street Journal, during the 8 years between 2007 and 2015 productivity growth averaged just 1.3% annually, which was less than half the pace that was seen in the seven year period between 2000 and 2007.
 
The talking heads on TV can’t seem to offer any real reason why productivity has gone missing. Some feebly suggest that globalization is the problem, or that automation has moved so fast that the benefits usually offered by technological improvements have lost their power.  But it would be hard to come up with a reason why trade, which has universally benefited local, regional, and international economies through comparative advantage and specialization, has suddenly become a problem. Similarly, when does greater efficiency become a problem rather than a solution? So they are stumped.
 
But these economists ignore the major change that has befallen the world over the last eight years, a change that has coincided neatly with the global collapse in productivity. The Financial Crisis of 2008 ushered in an age of central bank activism the likes of which we have never before seen. All the worlds’ leading central banks, most notably the Federal Reserve in Washington, have unleashed ever bolder experiments in monetary stimulus designed to reflate financial markets, push up asset prices, stimulate demand, and create economic growth. And while there is little evidence that these policies have produced any of the promised benefits, there is every reason to believe that the scale of these experiments will just get larger if the global economy doesn’t improve.
 
But very few brain cells have been expended about the unintended consequences that these policies may be creating. But let’s be clear, there is nothing natural or logical about a set of policies that result in an “investor” paying a borrower for the privilege of lending them money.  So in this strange new world, we should expect some collateral damage. Productivity is a primary casualty. Here’s why.
 
Another set of statistics that has accompanied the decline in productivity is the severe multi-year drop in business investment and spending. Traditionally, businesses have set aside good chunks of their profits to invest in new plant and equipment, research and development, worker training, and other investments that could lead to the breakthroughs and better business practices. The investments can lead to greater productivity.
 
But the business investment numbers have been dismal. But it’s not because corporate profits are down. They aren’t. Companies have the cash, they just aren’t using it to invest in the future. Instead they are following the money provided by the central banks.
 
Ultra low interest rates have encouraged businesses to borrow money to spend on share buybacks, debt refinancing, and dividends. They have also encouraged financial speculation in the stock market, the bond market, and in real estate. Investors may believe that central bankers will not allow any of those markets to fall as such declines could tip the already teetering global economies into recession. The Fed, the Bank of England, the Bank of Japan, and the European Central Bank have already telegraphed that they will be the lenders and buyers of last resort. These commitments have turned many investments into “no lose” propositions. Why take a chance on R&D when you can buy a risk free bond?
 
Higher interest rates are actually healthy for an economy. They encourage real savings, with lenders actually concerned about the safety of their loans. Without the backstop of central banks, speculators could not out bid legitimate borrowers who make capital investments that produce real returns. But with central banks conjuring cheap credit out of thin air, supplanting the normal market-based credit allocation process; the result is speculative asset bubbles, decreasing productivity, anemic growth, and falling real wages. Welcome to the new normal. 
 
If the cost of money is high, people think carefully about where they want to put their money. They select only the best investments. This helps everyone. When money is cheap, they throw darts against a wall. This is not the best use of societies' scarce resources. Is it any wonder productivity is down? 
 
Many economists are now saying that the Fed won’t be able to raise rates until productivity improves. But productivity will never improve as long as rates stay this low. This is the paradox of the of the new economy.
 
When will central bankers conclude that it’s their own medicine that is actually making the economy sick?  They will not make that connection until they succeed in killing the patient…and even then they may continue to administer the same toxic medicine to a corpse. The political pressure is just too great to ever admit their mistakes, so they repeat them indefinitely.
 
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Source: Commentaries By Peter Schiff

Speak Loudly and Carry No Stick

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.

By: 

Peter Schiff

Thursday, July 28, 2016

Theodore Roosevelt’s famous mantra “speak softly and carry a big stick” suggested that the United States should seek to avoid creating controversies and expectations through loose or rash pronouncements, but be prepared to act decisively, with the most powerful weaponry, when the time came. More than a century later, the Federal Reserve has stood Teddy’s maxim on its head. As far as Janet Yellen and her colleagues at the Fed are concerned, the Fed should speak as loudly, frequently, and as circularly as possible to conceal that they are holding no stick whatsoever. 
 
Roosevelt's "stick" was America’s military might, which in his day largely boiled down to the U.S. Navy, which he had enlarged and modernized. To demonstrate to a potential adversary that he was prepared to use these weapons, Roosevelt sent the fleet around the world in a massive show of force. However, he took care to couch the expedition in soothing rhetoric. He even ordered the battleships to be painted white to create the impression that they were angels of mercy rather than instruments of power. The combination proved effective. America’s global influence increased dramatically during his presidency even though few shots were fired.
 
The “sticks” that Janet Yellen is supposedly ready to employ are interest rate increases that are needed to help normalize the economy, fight inflation, and to stockpile ammunition to combat the next recession. Yet, in the last decade interest rates have essentially been fixed at zero. In fact, since the end of 2008 the Fed has raised rates a grand total of once…last December, by just one quarter of a percent. But what they have lacked in action they have more than made up for with torrents of talk. As a result of this “Loud Talk Policy,” American economic prestige in the 21st Century has fallen faster than it rose in the Roosevelt presidency.
 
Ever since the Fed finally wound down its quantitative easing programs back in 2014, the big question became when it would “normalize” interest rates, bringing them back to the three to four per cent levels that had been in place for much of the past century. Over that time, the Fed has issued countless statements, both officially and unofficially, that discussed why, when, and how fast it will raise interest rates. Never before have so many words been spilled and parsed over a policy development that never had any chance of coming to fruition.
 
The simple truth, I believe, is that the Fed can’t raise interest rates because its previous use of massive monetary stimulus to keep the country out of recession has created an economy that is hopelessly dependent on overly accommodating policy just to tread water. An economy is a physical thing. If it inflates too much, it must contract for balance and health to be restored. The Fed has committed itself to prevent that.
 
When the dotcom bubble crashed in the late 1990’s, the Fed and the Federal government inflated a much bigger bubble in housing to replace it. That produced some superficially good years, but the party couldn’t last forever. When that larger bubble popped in 2008, the government promptly blew up an even larger bubble in bonds, stocks, and real estate simultaneously to replace it. After six years and many trillions of dollars of purchases of treasury and mortgage-backed bonds (through its bailout and quantitative easing programs), the Fed has brought long term bond yields down to almost nothing, which has helped juice corporate profits, encouraged consumer borrowing, and reignited another increase in home prices.
 
Since there has been historically low growth in productivity and business investment over the past eight years, these rising asset prices appear to be the only pillars that support our otherwise anemic economy. The Fed must know that any significant increases in interest rates could knock out these pillars, toppling the phony recovery, and perhaps bringing on another recession that it would be hard-pressed to stop. I believe the Fed is much more aware than the typical Wall Street economists that the economy, as currently constituted, would have a difficult time handling interest rates that are even within shouting distance of normal.
 
But the difficult part for them is that they can never really admit that they find themselves in this trap. The Federal Reserve is now the country's primary economic cheerleader. Given how much weight the public ascribes to every utterance of the Fed, to admit that the economy is weak would be to create a self-fulfilling prophecy. So instead of keeping silent and acting decisively as TR would have done, the Fed talks in circles and does nothing. They talk over one another, sometimes saying the same thing, sometimes appearing to pull in opposite directions. Sometimes they just talk while saying nothing at all.
 
Yesterday’s Fed statement is just the latest in a seemingly endless string of announcements that are meant to convey a sense of optimism and a feeling that some action is getting closer, even though nothing is actually likely to happen. When the statement was issued, Wall Street expressed little concern that the Fed had done nothing for the fifth consecutive meeting, but took immediate notice that the Fed had concluded that “risks to the economy had diminished.” To many, this meant that the next increase in rates could come as soon as the next meeting in September. Yet they have been saying versions of this for the past two years, and it resulted in one lone December rate hike, which was followed by the biggest January stock market rout in more than a century. (Ouch, Matt Phillips, Melvin Backman,1/20/16)
 
There are any number of economic or political developments that could occur in the next six weeks that could easily provide the Fed with yet another convenient excuse not to hike, without having to admit the real reason for its inaction. Last time it was Brexit. Before that, it was a weak jobs report. Before thatit was market chaos in China. The bar keeps getting lower and they will always find something. Unfortunately, the media talking heads and the Wall Street mutual admiration society keep enabling them to continue the pantomime. 
 
But the show can not go on forever. There is no way to know when a little dog might pull back the curtain and reveal the truth behind the illusion. Should that happen, the absence of a stick will prove to be a huge problem for the entire nation.
 
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To order your copy of Peter Schiff's latest book, The Real Crash (Fully Revised and Updated): America's Coming Bankruptcy – How to Save Yourself and Your Country, click here.

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Source: Commentaries By Peter Schiff

Brexit is Just What the Dr. Ordered

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.

By: 

Peter Schiff

Friday, June 24, 2016

Janet Yellen should send a note of congratulations to Nigel Farage and Boris Johnson, the British politicians most responsible for pushing the Brexit campaign to a successful conclusion. While she’s at it she should also send them some fruit baskets, flowers, Christmas cards, and a heartfelt “thank you.“ That’s because the successful Brexit vote, and the uncertainty and volatility it has introduced into the global markets, will provide the Federal Reserve with all the cover it could possibly want to hold off on rate increases in the United States without having to make the painful admission that domestic economic weakness remains the primary reason that it will continue to leave rates near zero. 
 
For months the corner that the Fed has painted itself into has gotten smaller and smaller. It continues to say that rate hikes will be appropriate if the data suggests the economy is strong. Then its representatives continually cite (arguably bogus) statistics that suggest a strengthening economy, which cause many to speculate that rate hikes are indeed on the horizon. But then at the last minute the Fed conjures a temporary reason why it can’t raise rates “right now,” but stresses that they remain committed to doing so in the near future. But each time they conduct this pantomime, they lose credibility. Sadly, Fed officials are discovering that their supply of credibility is not infinite, even among those who would like to cut them a great deal of slack.
 
But the Brexit vote saves them from all this unpleasantness. Now when critics question the Fed’s unwillingness to deliver on the suggested rate hikes, given what they believe to be a strong economy, all the Fed needs to do is point to the “uncertainty” that will be in play now that the world’s fifth largest economy is disengaging from the European Union. And since this process is bound to be long, messy, and fraught with uncertainties (as there is no precedent for a country leaving the EU), this will be a handy excuse that the Fed will be able to rely on for years.
 
Brexit could also place severe strains and uncertainties on the global currency markets. The fear of financial losses could encourage investors to seek safe haven assets like gold and, at least for now, the U.S. dollar. Given that there is already much concern that the dollar is valued too highly against most currencies, and that this has created imbalances in the global economy, any surge in the dollar that results from Brexit may have to be fought by the Federal Reserve through lower interest rates and quantitative easing. This would rule out the potentially dollar-strengthening interest rate hikes that they supposedly planned on delivering. So as far as Janet Yellen is concerned, the British have given her the gift that keeps on giving.
 
On another level, the vote in the UK illustrates the fundamental inefficacy of the monetary and financial policies that have been implemented by the world’s dominant central banks and central bureaucracies. For years, global elites have been telling us that deficit spending, government regulation, and central bank stimulus is the best way to cure the global economy in the wake of the 2008 Financial Crisis. To prove these points, elite economists associated with the government, academia, and the financial sector have pointed to all kinds of metrics to show how their policies have been successful. But the man on the street perceives a very different reality. They know that their living standards have fallen, their cost of living has risen, and that their job prospects have deteriorated. They see a loss in confidence and economic stagnation when they are being assured the opposite.
 
This disconnect has fueled anti-establishment sentiment on both sides of the Atlantic. In the United States, it has given rise to the insurgent candidacies of both Donald Trump and Bernie Sanders. The unexpected successes of both reflect a deep distrust of the establishment. Such discontent would not be in play if the positive stories being told by the elites had made any resonance with rank and file voters.
 
The same holds true with the unexpected strength of the anti-EU voters in Britain. The “Remain” camp had the support of virtually all the elite members of the major UK political parties, the media, and the cultural world.  In addition, foreign leaders, including President Obama in a state trip to England, harangued British voters with warnings of economic catastrophe if the British were to make the grave error of defying the advice of their “best” economists.
 
Given all this, poll numbers that suggested the vote could be close had been dismissed. The elites, as evidenced by recent drifts in currency and financial markets, had all but assumed that British voters would fall into line and vote to remain. Instead, the people revolted. After having been misled for so many years by the very elites who urged them to remain, the rank and file finally asserted themselves and voted with their feet.
 
British voters may not know what they will get with an independent Britain, but they knew that something was rotten, not just in Denmark, but all over the European Union. The same holds true in the United States. Until our leaders can paint more realistic pictures of where we are and where we are going, we should expect more “surprises” like the one we got yesterday.
 
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Source: Commentaries By Peter Schiff

Lather. Rinse. Repeat.

Our weekly commentaries provide Euro Pacific Capital’s latest thinking on developments in the global marketplace. Opinions expressed are those of the writer, and may or may not reflect those held by Euro Pacific Capital.

By: 

Peter Schiff

Monday, June 6, 2016

Stop me if you’ve heard this one before: A Fed official walks into a bar and says the economy is improving and rate hikes are appropriate. The patrons order another round to celebrate. Then disappointing data comes out, the high fives stop, and the Fed official ducks out the back…only to come back the next day saying the same thing. Anyone who pays even the smallest attention to the financial media has experienced versions of this joke dozens of times. Yet every time the gag gets underway, we raise our glasses and expect the punch line to be different. But it never is. Last week was just the latest re-telling.
 
For nearly a month the Fed’s bullish statements stoked optimism on the economy and raised expectations, based particularly on the most recent FOMC minutes, for a summer rate hike. But these hopes were dashed by the May non-farm payroll report, which reported the creation of only 38,000 jobs in May, the worst monthly performance in six years, based on data from the Bureau of Labor Statistics (BLS). The number missed Wall Street’s estimate by a staggering 120,000 jobs. If not for the 37,000 downward revision reported for April (160,000 jobs down to 123,000), May could have shown a contraction. This would have constituted a major black eye to the Obama Administration’s favorite talking point that its policies have led to 75 months of continuous job gains. (6/3/16, Democratic Policy & Communications Center).
 
To make the report even stranger, the plunge in hiring was accompanied by a drop in the unemployment rate to just 4.7%. Of course the fall in the unemployment rate was a function of another major drop in the labor force participation rate to just 62.6%, matching the June 2015 rate, which was the lowest level since the late 1970s (BLS). So the unemployment rate did not fall because the unemployed found jobs, but because they stopped looking. The market reaction was swift and sharp, as it always has been when a fresh shot of cold water has been thrown in the face of market boosters. The dollar fell hard and gold rose sharply.
 
But we can rest assured that despite any embarrassment that the Fed may be experiencing for having so gloriously misdiagnosed the current economic health, it will be right back at it in a few days, telling us about all the positive economic signs that are emerging and how it is ready and willing to start raising interest rates at the earliest opportune moment. Boston Fed president Eric Rosengren waited exactly 48 hours to start that campaign as he sounded bullish notes in a Monday speech in Finland. (6/6/16, Greg Robb, MarketWatch)
 
Given how many times this scenario has unfolded, leading to the point where even reliable Fed apologists like CNBC’s Steve Liesman have begun questioning the Fed’s credibility, one wonders what the Fed hopes to achieve by continuously walking into the bar with a new smile. But this performance is the only policy tool it has left. The Fed appears to believe that perception makes reality, so it will never stop trying to create the rosiest perception possible. It may view its own credibility as expendable.
 
There is also the possibility, however unlikely, that the Fed officials are not just trying to create growth through open-mouth operations, but that they actually believe that their policies are working, or are about to work. This would be as dogged a commitment to policy as medieval doctors had for bloodletting, which they thought was a useful therapy for a variety of ailments. Doctors at that time had all kinds of seemingly plausible reasons why the technique was effective. If the patient did improve after draining blood, it was taken as a sign of validation. But they would continue to apply the leeches even if the patient did not improve. Failure was simply a sign that more blood needed to be drained. Similarly, central bankers consider ultra-low, and even negative, interest rates as an ambiguous stimulant that will create growth when applied in large enough doses.
 
But what if modern central bankers, much like medieval doctors, are operating on a wrong set of assumptions? We know now that draining blood creates conditions that actually decrease a patient’s ability to fight infection and recover. Perhaps, one day, bankers will come to a similarly delayed conclusion about how zero and negative interest rates have prevented a real recovery that would otherwise have naturally taken place.
 
That’s because artificially low interest rates send false signals to the economy, prevent savings and investment, and encourage reckless borrowing and needless spending. They prevent the type of business and capital investment that is needed to create real and lasting economic growth. But don’t expect bankers, or their cheerleaders on Wall Street, the financial media, government, or academia, to ever make this admission. They do not believe in the power of free markets. They believe in government. Such a leap is simply beyond their powers of comprehension.
 
But there is another cycle here that is much more influential on the current market dynamic and should be much easier to spot. When the Fed talks up the economy and promises rate increases, the dollar usually rallies. When the dollar rallies, U.S. multi-national corporate profits take a hit, and the market falls. When the market falls, economic confidence falls and puts pressure on the Fed to maintain easy policy. This is a loop that the Fed does not have the stomach to break.
 
Because the Fed waited more than seven years to lift rates from zero, the cyclical "recovery" is already nearing its historical limit, if it's not already over. This could put the Fed into a position of raising rates into a weakening economy. Normally it does so when the economy is accelerating. Some identify this delay as the Fed's only policy error. But had it moved earlier, the recession would have simply arrived that much sooner. The Fed's actual policy error was thinking it could build a "recovery" on the twin supports of zero percent interest rates and QE, and then remove those props without toppling the “recovery.”
 
But despite all this, there are those who still believe that the Fed will deliver two more rate hikes this year. Given the anemic growth over the past two quarters, the recent plunges in both the manufacturing and service sectors, average monthly non-farm payroll gains of only 116,000 over the past three months (most low-wage, and part-time) and the stakes contained in the election that is just six months away, such a conclusion is hard to reach. Instead, I expect we will get the same bar gag we have been getting for the past year. Many of those who now concede that a June hike is off the table still believe July to be a possibility. I believe the Fed will go along with that hype until it can no longer get away with it…then it will start bluffing about September, or perhaps December.
 
The Fed has to keep talking about rate hikes so it can pretend that its policies actually worked. But the truth is that the Fed policies have not only failed, they have made the problems they were trying to solve worse, and raising interest rates will prove it. So the Fed resorts to talking about rate hikes, to maintain the pretense that its policies worked, without actually raising them and proving the reverse. This can only continue as long as the markets let the Fed get away with it or until the numbers get so bad that the Fed has to admit that we have returned to recession. That is the point where the Fed’s real problems begin.
 
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Source: Commentaries By Peter Schiff