The landscape of modern monetary policy has become a source of skepticism at Economic Prism. Entrusting a small group of unelected technocrats with the task of setting key lending rates seems to contradict the essence of a free society. This is our perspective.
Your interpretation may vary, but we believe that willing lenders and borrowers are far more capable of negotiating a fair interest rate on an individual basis than Janet Yellen and her colleagues are when they attempt to dictate terms for everyone. The Federal Reserve’s repeated attempts to shape the economic landscape have often ended in chaos.
When the stock market plummeted on October 19, 1987, newly appointed Fed Chairman Alan Greenspan pivoted monetary policy in a radically different direction. He seized the moment, reducing the federal funds rate by half a percentage point from 7.5% to 7%. This influx of liquidity bolstered the market, leading to a rapid recovery in stock prices.
This swift rebound elevated Greenspan to rockstar status, earning him accolades from Wall Street. Many flocked to stock mutual funds in search of wealth, and Bob Woodward even penned a book praising Greenspan’s leadership.
More significantly, the concept of the “Greenspan put” emerged as an unofficial Federal Reserve policy. This policy entailed injecting liquidity into the markets whenever a crisis unfolded. Successors like Bernanke and Yellen have continued this trend.
Mile Marker One
The Fed has repeatedly inflated financial markets that desperately needed correction. They intervened after events like Black Monday, the Gulf War, the Mexican crisis, the Asian financial crisis, the Y2K scare, the dot-com bubble burst, the 9/11 attacks, and the 2008 credit crisis. While such actions may have alleviated immediate pain, they have fostered greater risk and instability in the markets.
Currently, the stock market faces yet another challenge. The anticipated market rally on Tuesday quickly faded into a 200-point loss on the Dow. Wednesday finally brought the boost investors had been eagerly awaiting, followed by another increase the day after.
However, don’t be deceived. This rally does not signify the end of the market’s downward trend, nor does it herald a resurgence to record highs. Rather, it serves as mile marker one on the stock market’s tumultuous descent.
The Fed’s response will be closely watched, especially since today’s circumstances are far different from those of 1987; interest rates are not hovering at 7.5% ready for cuts. Instead, the federal funds rate has been maintained at nearly zero for the past seven years. A shift to negative interest rates seems inevitable, but how they will implement this remains unclear.
To execute negative rates, the Fed would need to effectively penalize savers, making it so unattractive to hold cash that spending becomes the only logical choice—leading to more borrowing and spending.
Manna from Heaven
In the meantime, the Fed continues its familiar dance of indecision. It has hinted at backing away from earlier commitments to raise rates in September. Naturally, such news has been well-received by the stock market. A report from the New York Times encapsulates this sentiment…
“Once again, the Federal Reserve helped save the day for investors.
“The United States stock market soared in late trading on Wednesday, ignoring earlier declines in Europe and China. This rally, occurring after several days of significant downturns across major global markets, was catalyzed by reassuring statements from a leading Fed official.
“During a news briefing in New York, William C. Dudley, president of the Federal Reserve Bank of New York, stated that the recent financial market turmoil posed risks to the U.S. economy. He stressed that the prospect of raising interest rates next month was becoming ‘less compelling.’
“Mr. Dudley’s words were manna for investors who had been starved of good news in the preceding days.”
Thus, the perception of “manna from heaven” continues.
Sincerely,
MN Gordon
for Economic Prism
