Fed Update——Hawks, Doves and Chickens


Gallus Gallus Domesticus and the Ghost of 1937

Just before writing this comment, we happened to come across a truly funny tweet by the WSJ’s Greg Ip, which you can see below, including our reply:

  PreparationJon Hilsenrath seems to seriously believe the markets weren’t “prepared” enough for a ridiculous rate hike of 25 bps at most, from the current level of – zero!



Of course we would like to thank Ms. Yellen and the merry pranksters for helping to set up a better shorting opportunity, but all kidding aside, we actually believe that Hilsenrath is in a way correct. They are dead scared of being seen as setting off a market crash, and they know of course that more than six years of humungous money printing have achieved little besides blowing another bubble. In fact, the real economy, though not yet in recession, looks decidedly lame.

FOMC members are probably wondering why that is so, considering their intellectual background. Their economic theorizing seems to be an odd mixture of Keynesianism and Monetarism, sort of mixing the worst aspects of the two schools of thought. We happen to believe that Joseph Salerno was actually on to something when he referred to this as the “John Law School of Economics”, because that’s what it basically is. In “Money, Sound and Unsound” Salerno writes:


The stable money doctrine was soon discredited, only to be replaced by the vastly more inflationary spending doctrine propounded by John Maynard Keynes, himself a former advocate of stable money. In its essentials, Keynes’s doctrine harked back to John Law and the so-called “monetary cranks” of the nineteenth century. Keynes maintained that depression was simply the result of a deficiency of total spending or “aggregate demand,” which was a chronic condition of the market economy. The only remedy for this problem, he argued, was government budget deficits that directly injected money spending into the economy combined with an expansionary monetary policy to lower interest rates and stimulate private investment spending.


By the late

1970s, Keynesianism as a policy program had lost its credibility and it was supplanted by monetarism, a movement led by Milton Friedman which had been growing in influence in academic economics since the early 1960s. But monetarism was nothing more than Fisher’s stable money principle supported by a seemingly more sophisticated version of the quantity theory of money restated in Keynesian terminology.


By the early 1990s, a new theoretical consensus in macroeconomics had emerged known as New Keynesian economics, which synthesized elements of Keynesianism, monetarism, and New Classical economics, an offshoot of monetarism.


(emphasis added)

And that mixture is where things remain to this day. The only “new” aspect as far as we can tell is that the “NAIRU” doctrine has been warmed up again by some of the more dovish members of the FOMC such as Charles Evans (NAIRU is based on the fallacious Phillips curve, which in turn is a prime example for why economic theory simply cannot be deduced from “empirical data”).

It is perhaps worth noting that at least seven Nobel prizes have been won for papers debunking the Phillips curve in some shape or form. We hasten to add that receiving the Sverige Riksbank’s prize (it is not a “real” Nobel prize, it is a central-bank administered prize “in the memory of Nobel”) does not make one a good economist. It is essentially meaningless. Often two or more economists with diametrically opposed ideas are getting the prize at the same time – and often the ideas of both are humbug. We have actually come to view this prize as a contrary indicator, and the fact that Friedrich Hayek won the prize as well should really be regarded as the exception proving the rule (we believe he only won because the events of the 1970s so thoroughly discredited Keynes, at least for a while).


FF rateThe administered interest rate shall remain at zilch… – via StockCharts, click to enlarge.


Anyway, the one event in economic history that can probably be considered the most influential informing the policy of the modern-day FOMC is the Great Depression – an outlier event that should mainly forever stand as a warning against willy-nilly credit expansion and heavy interventionism both before and during an economic downturn. Unfortunately for all of us, the “scientific doctrine” of our modern-day policymakers is characterized by having taken away all the wrong lessons from this event. The ideas of the so-called “depression expert” Ben Bernanke continue to be a dominant feature of the thinking of the central planners.

There was a “depression within the depression” in 1937, which probably is the main event driving the board’s current views. We have discussed this in some detail previously (see “The FOMC and the Ghost of 1937”), but briefly, it is held that the Fed had tightened policy “too early” in 1937 and that FDR was mistaken in reducing his government’s deficit spending. This is of course complete nonsense. While it is true that these actions helped trigger the downturn, the downturn itself was inevitable in any case. The bust merely unmasked the malinvestments that had piled up due to the heavy monetary pumping and outrageous deficit spending that went on previously. As always in such situations, scarce capital had already been consumed during the preceding boom – and then everybody bemoaned the discovery of this fact.

In other words, postponing the tightening move would merely have made matters even worse – and the same holds for today’s postponement. As Bill Bonner noted in his recent missives on “Janet Yellen’s Brain at 4:00 a.m.” (part 1 and part 2), Ms. Yellen and her colleagues probably fear nothing more than getting blamed for a financial debacle and an economic bust on account of “tightening too early”. And so they have opted to continue to let the unnatural situation fester, in which we are all supposed to pretend that the cost of capital should be rationally set at zero.

In short, they are neither hawks nor doves – they are chickens.


ChickenLittleA new kind of bird on the FOMC board….


For the Kremlinologists

Kremlinologists should once again take a look at the WSJ’s FOMC statement tracker, which compares the July to the September statement. As you can see, the committee remains as clueless as ever. This is by the way not a complaint; we are just as clueless as to the future of the economy, apart from a few educated guesses – but then again, we aren’t trying to set the price of credit for the entire economy.

There was one hawkish dissident, namely from Richmond fed president Jeffrey Lacker. This is no surprise; he was definitely most likely to dissent with a continuation of ZIRP. What surprises us the most about Mr. Lacker is why he hasn’t resigned a long time ago, given that he often expresses quite level-headed views. Does he really believe that money and credit should and can be centrally planned?


0620_ge_JeffreyLacker_630x420Lone hawkish dissenter from the ZIRP policy: Jeffrey Lacker.

Photo credit: Andrew Harrer / Bloomberg


The decisive passages in the statement for assorted liquidity junkies were the following:


“To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate.


The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.”


After all the angst that preceded this FOMC meeting, “business as usual” obviously remains in place. However, people have likely become inured to this. It may no longer be enough to keep all bubble activities afloat.



The Fed remains in a box of its own making. We are beginning to doubt whether central bank will ever be hike rates again voluntarily. What is however eventually highly likely to happen is that the markets will force the Fed to act – or as Bill Fleckenstein puts it, “the bond market may take the printing press away from them”.

Lastly, when FOMC members point out that current low “inflation” figures (meaning CPI rates of change) are likely “transitory”, they are not wrong – this is simply a matter of base effects in the calculation of CPI. However, as we have pointed out previously, an eventual rate hike won’t necessarily put a brake on further increases in the money supply, due to the central bank’s current modus operandi.

As things stand at present though, money supply expansion depends primarily on the commercial banks – and they may prove unwilling to increase the stock of fiduciary media much further in view of how weak the economy appears to be. As we have often stressed, if the economy’s pool of real funding is sufficiently exhausted, there may be literally “nothing left to lend”.