The recent decision by Federal Reserve Chair Janet Yellen to maintain the current zero interest rate policy sparked exuberance on Wall Street, propelling stock prices to near record highs. However, after more than six years and over $3 trillion allocated to direct asset purchases, what real options does the Fed have left?
While they could initiate the challenging task of recalibrating credit markets away from their overly indulgent policies, doing so would risk the fragile financial structure the Fed has painstakingly built. In other words, they would be unintentionally setting off a financial disaster that could bring crashing down the precarious stock market.
This daunting prospect has resulted in the Fed choosing its words carefully, reminiscent of Bill Clinton’s cautious statements during a Congressional impeachment hearing. “Just because we removed the word ‘patient’ from the statement doesn’t mean we are going to be impatient,” said Yellen. So, it seems they might raise rates soon—but not just yet?
This vague communication is fundamentally unhelpful. It is astonishing that in 2015, despite our advancements in technology and infrastructure, the financial system hinges on the ambiguous statements of a frail bureaucrat with a carefully styled hairdo. This entire volatile scenario is deeply flawed.
The consequences we face today stem from a misguided belief prevalent in the early 20th century. The idea that centrally-planned economies can ensure abundance has repeatedly proven to be false. The notion that the business cycle can be “scientifically managed” has resulted in considerable disappointment and hardship.
Great Disparities
The primary driver of economic distortions has been a blatant disregard for common sense in managing the global money supply. The Fed and other central banks’ attempts to scientifically manage the economy have twisted reality in ways previously deemed impossible.
Instead of smoothing out the business cycle as promised, monetary policy has actually intensified it. Cheap credit leads to rising asset prices, followed by additional cheap credit to prevent these prices from sinking. Consequently, booms become more extreme, while busts grow more severe, all while the real economy stagnates.
“The reason the Fed is entangled in a massive trap is that history is closing in on it,” David Stockman, former Congressman and Director of the Office of Management and Budget under President Reagan, explains. “We have now endured nearly three decades of increasingly aggressive monetary inflation—culminating in 80 months of zero money market rates and extensive monetization of debt tied to real labor and capital resources.”
“This has created a dangerous and widening disconnection between the reality of the main street economy and the nominal values in the financial system. Although often referred to as ‘financialization,’ it means that the Fed’s efforts for monetary stimulus are now trapped; any additional liquidity essentially becomes confined within the financial realm, inflating existing asset values rather than benefiting the broader economy. In other words, any stimulus fails to escape the confines of Wall Street.”
“As a result, the financial sector has expanded at a pace far quicker than the real economy over the past few decades, even when scrutinized against nominal GDP and considering the significant element of inflation in that measure. The link between the two has become stretched like a rubber band on the verge of snapping. The Fed’s concern about a potential drastic collapse of the financial system reflects its lack of understanding of this imminent danger.”
What Comes After the Boom
In straightforward terms, the global financial system and the economy stand in stark opposition to one another. The forces of inflation and deflation are at an unprecedented tension. Signs indicating this breaking point are evident everywhere.
Stock prices have surged to record levels, while real wages have diminished. Additionally, stock prices have outpaced corporate earnings to an extent rarely seen in history. The market capitalization has also eclipsed gross domestic product by margins indicative of major market peaks.
Clearly, something isn’t aligning. Wages and corporate profits must either increase, or stock prices need to decline—a correction is inevitable. Given the current phase of the business cycle, it appears likely that stock prices will be the first to adjust downwards.
Time is running out for the central bank-controlled fiat money system. What currently holds it together is an extraordinary financial bubble. The boom has unfolded, the bubble exists, but what follows the boom is yet to be seen.
To grasp the potential aftermath, reflect on the tumult of the 2008 Financial Crisis and the Great Recession. Consider the extensive chaos and economic damage that followed. Contemplate how these events had a devastating impact on the middle class.
Now, envision a situation that could be ten times worse. If you can fathom that, you have a glimpse of what may come after this current boom.
“This issue not only threatens financial stability; it may also pose a significant challenge to political stability,” Stockman warns. “The dramatic disparity between the average household net worth of $300,000 and the median net worth of $45,000 suggests that societal unrest may be on the horizon.”
Sincerely,
MN Gordon
for Economic Prism
