Fed Takes Increasingly Drastic Actions

Last fall we began to follow the story about the Federal Reserve starting up unusual activity in the repo markets. First, they said these were just temporary actions related to some quarterly tax issues. Then they announced these unusual operations would be extended in 2020 and we saw the amounts jump considerably from time to time. The Fed continually assured the public that there is nothing to be concerned about and that we should not label their actions as QE (Quantitative Easing). More and more skeptics have questioned if the Fed operations suggest trouble behind the scenes.

Fast forwarding to the present, now we have a full blown global pandemic and markets around the world reeling into what seems like free fall. Oil prices collapsed due to a combination of market anticipation that world oil demand would drop due to the pandemic and a dispute between Saudi Arabia and Russia over whether to cut supply in response to a drop in demand. 

Meanwhile, the impact of the virus pandemic on the US government continued to grow. At first it seemed as if government officials did not take the threat seriously enough. While they did begin to ramp up a government task force on the problem, the public seemed to sense that the threat from the pandemic was moving faster than the official response. This has led to a state of what I might describe as "mild panic" in the US with people reacting to their fears in a variety of ways including wiping out retail supplies of some key basic consumer goods. 

Of course this kind of sudden panic buying puts enormous stress on our "just in time inventory" distribution system for those products in high demand. All of this creates an atmosphere of public uncertainty and is conducive to the potential for the sense of panic to ramp up depending upon what happens in the coming weeks. A lot will be determined by how effectively the pandemic threat is contained and the public perception of whether our leaders and public officials handled the crisis well or not.

Now the Fed fires another major round of ammunition in an effort to support markets and ease investor fears that this crisis will spill over into the financial system and threaten its stability (Initial market reaction was not good). Clearly, the trust and confidence of the public in its leaders is going to be tested both on the health care front and the economic front. This is exactly the kind of situation we have written about here on this blog for years now. We have arrived at a key point in time where we find out if all this is just another bump in the road for the our current system or this leads to a lack of public trust and confidence that shakes the stability of the current system. It's important to recall that our entire present system fully depends on the public trust.

At this time, all we can do is make a few observations as we wait to see how all this actually unfolds. As we have said here many times, what matters is what actually happens, not what any expert or official predicts will happen. As we stand today, things could go either way and I doubt that anyone knows for sure which direction things will go in terms of whether our present monetary and financial system emerges from this in tact or radically changed. We will monitor it here as best we can. For now, here are a few observations:


- We need to watch the Fed very closely. They have continued to assure us that things are fine and stable even as we see clear evidence that markets are not stable and Fed actions in response are becoming more urgent, more drastic, and more frequent. The Fed will say no one could the pandemic coming, but so far it's not good look for the Fed. They seem behind the curve whether they are or not.

- We are getting an interesting peek into how the general public will react in a crisis situation where genuine fear is motivating daily decision making. I am observing how people are reacting to this (at least in my area) with interest. On one level, there is not a panic leading to any kind of civil disorder. But clearly there is a sense of unease leading people to flock to panic buy key consumer goods despite being told that there is no reason to fear being able to acquire necessary goods. This suggests to me that down deep, people don't fully trust that public officials will handle things well. So far, it's probably just people wanting to err on the side of caution. But if things continue on such that instability persists over time (on the health front and on the economic front), it will be interesting to see how the public mood may change in this regard and become more intense.

- There are plenty of suspicions out there that this whole crisis is an engineered event for the very purpose of testing to see how the US general public will react to a situation like this. There are a variety of proposed culprits. I don't view things that way at this time, but there are many people who have suspicions about it and I try to keep an open mind. I suspect that how officials handle this going forward will either ramp up the intensity of suspicions like that or quell such suspicions. Only time will tell us.

- We should continue to watch what happens in all markets. This includes not only stock markets, but the gold market and the strength of the US dollar. Combined these will continue to provide some hints as to whether public trust and confidence is holding up or faltering. 


Reactions to the Fed Rate Cut and QE Announcement:

Nouriel Roubini

Mohamed A. El-Erian

Jim Rickards

Jim Rickards #2

CNBC - Dollar Weakens after surprise rate cut

Gold is the only thing to own now (Kitco News)

Alternative Media Viewpoint from Egon Von Greyerz

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Added comment: The purpose of this blog has been and is to monitor events that might lead to some kind of change in our present monetary and financial system. While the current events certainly fall into that purview because of the potential stress to the financial system, it should be said that the financial and economic impact from the events are not as important as the health and safety of all people. This post on the Twitter feed of Dr. Judy Shelton is a reminder of what they are going through in hard hit Italy.

The health pandemic confronting the world right now is outside our area of expertise here so we have refrained from covering that to any significant degree. But as we come across information on this, if we feel it is credible information that might be helpful to anyone, we will certainly cover it here. If we do not post information, it will be because we do not feel we have the expertise here to determine if the information is credible. The recommendations that have been widely circulated to the public about how to combat the virus seem like reasonable common sense proposals and we would certainly encourage readers to follow them. As with any contagious disease, it makes sense that each of us doing what we can to try and limit the spread of the disease is just prudent behavior.

BIS Research Paper - Ability of the Fed to Create Easy Money is Key to Market Dominance of the US Dollar?

The Bank for International Settlements (BIS) has released this report which examines how Fed policy might impact the dominance of the US Dollar. (see detailed report here). This report is pretty lengthy and technical, but the quote below from the Conclusion section of the report caught my attention. (I added underline for emphasis)

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 Conclusion


"What do our results imply for the future of the dollar? Many explanations of the dominant role of the dollar in the international monetary system feature arguments like inertia, size, network externalities, and market liquidity. All these arguments suggest that changes in the dominance status of a currency occur very slowly. 

By contrast, our results suggest that the dollar can lose its dominance if the expectations that the Federal Reserve is able to stimulate the economy and reduce real debt burdens of firms during global crises actually decline. As this view relies on the beliefs of market participants, this change might occur abruptly."

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My added comments -- There are two points to make here:

1) Please notice that they first point out how that the conventional views of the dominance of the US dollar lend credence to the idea that any change in that dominance will occur slowly over time. This is what we have been reporting here for some time.

2) Next please note that this report seems to suggest virtually the opposite of what the conventional wisdom is on this topic. It says "the dollar can lose its dominance if the expectations that the Federal Reserve is able to stimulate the economy and reduce real debt burdens of firms during global crises actually decline." It appears to say the easy monetary policy actually supports the dominance of the US dollar rather than weakens it as most would assume.

I will leave it to readers to decide if this is a valid analysis of potential market reaction to easy Fed monetary policy designed to "stimulate the economy" during a crisis. It is also interesting to note that their analysis also suggests that "the change might occur abruptly". 

If there is some kind of crisis of confidence surrounding the US dollar during the term of President Trump, we can assume the President will blame the Fed's policies for the crisis (he has already shown he will do that). This report seems to suggest that the blame should fall on a market perception that the Fed is unable to implement an easy money policy to "reduce the real debt burdens of firms" during the crisis. My assumption is that the BIS report is implying that Fed easy money policy would stimulate inflation and therefore reduce the "real debt burden" for entities that are in debt at the time and that markets would perceive that to be the case.

You may ask: But President Trump has been criticizing the Fed for not being easy enough with monetary policy, so doesn't he agree with the BIS report? On the surface that may appear to be the case. However, the BIS report may be suggesting that the Fed should be allowed to tighten now (against the wishes of President Trump) so that when the next crisis arises, they will have the ammunition and credibility to revert back to easy money to "stimulate the economy" during a crisis. The report does not say that, but it is a reasonable inference to make and one we might well see the Fed argue if a dollar crisis does emerge in the future and the President blames the Fed for it.

So we can keep an eye on this to see if this kind of debate does emerge should the US dollar suffer any crisis of confidence during the term of President Trump. If no crisis occurs, all of this is somewhat irrelevant. If a crisis does occur, the blame game will surely ramp up and then these kinds of debates will matter because who the public blames for the crisis will determine who they trust to move forward to fix the crisis. 

At this point, it is fairly easy to predict that President Trump will attempt to blame the Fed if any major crisis does take place during his term. His opponents will certainly will attempt to blame him (tariffs, trade wars, sanctions, etc). This will clearly become a political fight between very powerful entities, so we can expect that it won't be fought politely as if just debating routine policy differences. The people will be forced to pick a side during a heated battle with who will have political power going forward hanging the balance if we get a major crisis. I hope this will not happen because the odds of a good outcome for the general public are low under the current conditions where obtaining and holding political power is viewed as a life or death matter to those engaged in the fight. 

However it could happen. So we need to be alert to the risk and monitor market reaction closely heading into the next US elections. Obviously, a sharply falling stock market, a sharply falling US dollar, and a sharp rise in gold prices are all signals things are not going well. Continued stability in those markets suggests they don't see a major crisis headed our way. Keep in mind though, even markets can get taken by surprise. I doubt the markets anticipated two oil tankers in Hormuz would be hit with an attack before it happened.

The Most Important Question Heading into this Fall for My Blog, The US, and the World

Is the Trump Economic Boom a Mirage? 

This is the lead question in a recent article by Jim Rickards that looks at whether or not current Fed policy might lead the US into a new recession. I cannot think of a more important question to consider at this time. The answer to that question will determine if regular blog articles continue here, if the US economy remains strong, what happens to the US dollar, and then even what will the impact be on the entire global economy. 

Below are some excerpts from the article by Jim Rickards and a few added comments. It is hard to overestimate how important the answer to this question really is. If the US economy is as strong as it is reported to be and is able to sustain a higher level of GDP, the political landscape tilts towards President Trump and against any substantial major changes in our present monetary system. This would mean that this blog would likely have little news to report or cover leading to no need for regular articles. Most voters will probably be happy enough to keep things pretty much as they are. The status quo remains likely to stay in place.

On the other hand, if the US economy is not as strong as it is reported be or cannot sustain a high enough level of GDP, the door opens for all kinds of disruption and change. The political environment likely changes. The markets and US dollar are likely less stable. We have to go on alert to watch for signals that another deep recession (or even a new crisis) could emerge. So the the stakes are very high in regards to the answer to this question. Below are some excerpts and then a few added comments.

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from Jim Rickards article - The Fed is on a Collision Course

"Is the Trump economic boom a mirage? The data say yes, but the Fed models say no. The Fed has a long track record of sticking to its model-based approach and missing major turns in the U.S. economy.

Current Fed policy will push the U.S. economy to the brink of recession later this year. When that happens, the Fed will have to reverse course and ease monetary policy. This will send the dollar crashing while gold and the euro soar."

. . . . 

"As for the Trump bump, growth in the first quarter of 2018 was 2.0%, slightly below the average since June 2009. Growth for all of 2017, Trump’s first year in office, was 2.6%, slightly above the 2.14% average in this recovery but not close to the 3.5% growth proclaimed by Trump’s supporters.

In short, growth under Trump looks a lot like growth under Obama, with no reason to expect that to change anytime soon. In fact, the head winds caused by the strong dollar, the trade wars and out-of-control deficit spending may slow the economy and bring future growth down below the average of the Obama years.

Into this mix of weak growth comes the Federal Reserve, which is tightening monetary policy, reducing the base money supply and supporting a strong dollar. All of these policies are associated with slower growth ahead, an inverted yield curve and a high probability of recession."

. . . . 

"Simultaneously, the Fed is reducing its balance sheet (destroying base money) at an annual tempo that will reach $600 billion per year by end of 2018. This policy is completely unprecedented in the 105-year history of the Fed, so its economic effects are unknown.

My estimate, and that of others, is that this balance sheet reduction policy is equivalent to four 0.25% rate hikes per year on top of the four already planned. The combined effect is the same as the Fed raising rates 2% per year off a near-zero rate base as recently as December 2015.

Bearing in mind that monetary policy works with a 12–18-month lag, this extraordinary tightening policy in a weak economy is almost certainly a recipe for a recession.

Why is the Fed tightening if the economy is fundamentally weak and the probability of a recession is so high?"

. . . . . 

Click here to read the full article and see Jim's answer

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My added comments: This article lays out very well a situation I have been monitoring in terms of what to do about regular blog articles here. If the US economy holds up and really does sustain a strong level of GDP, not much is likely to change very soon. Most people will be happy (or at least satisfied) and the present system is unlikely to be at major risk for a game changing crisis. As I have mentioned here, there is no reason to continue to try and cover an event that is not happening (major monetary system change) just for the sake of trying to produce regular blog articles.

On the other hand, if the situation goes the other way, things could change a lot and then the door to major monetary system change could also open up. Just imagine if things do go south with the US economy. Political opponents of President Trump will seize upon the situation to disrupt his agenda and undercut his political power base. I think it is reasonable to guess that President Trump will point a finger directly at the Fed as the cause of the problem (too tight monetary policy). This would be a very messy situation with all kinds of potential for disruptive changes with the huge political divide that exists today in the US and the country essentially split in half. 

Also, it is not as though no one is urging the President to be more proactive on the concept of monetary reform. The Wall Street Journal recently called on him to use the current environment to educate the public on why reform is needed and start the process. Dr. Judy Shelton has said this might be the right time to think about monetary system reform. The New York Sun has gone a step further in this article and suggested that if the President does not become more proactive in educating the public on this issue and seizing the opportunity, he may find himself in some political trouble if the economy does take a downturn.

This is why I originally decided to see how things go until this fall in terms of future regular blog articles. By the time the November 2018 elections take place, we should have a decent idea where things are headed. The 2018 mid term elections probably either keep the Trump Administration economic agenda in place or severely disrupt it if the Democrats take control of the US House of Representatives. If the Trump economic boom shows signs of being a mirage before the elections, the prospects for change go up. If the economy seems to be doing fine, the prospects for major change go down.

It's a gigantic question and the answer has worldwide implications. We won't try to make any predictions here. All we can do is just observe what actually happens and report it. 
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Added news notes 8-27-18:

Another article calling for monetary system reform - this one says events in Turkey provide another example as to why it's needed. Here's a quote from the article:

"The lesson to learn from the Turkish crisis does not only concern Turkey. It is one more crisis which calls for a reform of the international monetary system."


CNBC - US - Mexico reach trade agreement and new NAFTA deal anticipated

CNBC - Markets not worried about Trump because of the "Pence Put"