Review of Trillion Dollar Triage: How Jay Powell and the Fed Battled a President and a Pandemic---and Prevented Economic Disaster by Nick Timiraos

We remember when the 2020 pandemic was first hitting our shores being puzzled by the financial implications. If a movie theater is forced to close, does it still have to pay rent? If not, does the landlord still have to pay its mortgage? If not, does the bank that holds the mortgage still have to pay interest? There were proposals to pause or stop financial time until the pandemic passed.

We were not sure what would happen but we thought that business owners would bear the brunt of it. After all, from a capital structure perspective, equity is the cushion. By putting up the equity investment - and agreeing to be in the first loss position - the movie theater owner is able to borrow many of the inputs to its business, such as the real estate it occupies and likely the furniture and fixtures of the theater too. At the end of the day, it gets an equity-like return on its equity. Fair reward for the risk.

But equity investors did not lose their equity as a result of the pandemic, for the most part, even in sectors where demand collapsed. Royal Caribbean Cruises shares (RCL) have now climbed back to where they were in February of 2020, even though shareholders were diluted. Instead of a wave of bankruptcies and business failures, the Federal Reserve and the federal government stepped in with unprecedented financial support such as substantial weekly payments to the unemployed and direct purchases of junk bonds and other riskier securities by the central bank.

We have become more cynical and hopefully wiser after sixteen years of writing this blog. One thing that we mistook when the pandemic was setting in is that the role of business owners is more than just financial, and it needs to be looked at more broadly than just from a capital structure perspective. 

We know that there is a huge difference within industries between the most productive and least productive firms. You can read about that in a paper called "What Determines Productivity?" by Chad Syverson, whose research has found that plants at the 90th percentile of an industry productivity distribution make twice as much with the same measured inputs as the 10th percentile plants. (He also finds that the productivity for firms has “serial autocorrelation,” that is, firms stay efficient or inefficient from year-to-year.)

His results imply that it would have been hugely value-destroying to take American enterprise and auction it off during the middle of a pandemic to curmudgeons on the sidelines holding T-bills. So, regardless whether bailouts are "fair" or good policy, we have come to recognize that they need to be incorporated in our investing framework.

We came up with a reading program in that vein that starts with Trillion Dollar Triage, which is a hagiography of Federal Reserve chair Jerome Powell by his current Wall Street Journal mouthpiece, Nick Timiraos, who calls Powell an "unassuming civil servant."

Trillion Dollar Triage gives a chronicle of Powell's career before the pandemic. He was a lawyer, investment banker, and private equity investor for the first 13 years after he graduated from Georgetown Law. He was a Treasury under secretary during the G.H.W. Bush administration, worked for a think tank from 2020-2012, and was nominated to the Fed's board of governors in 2012.

During the years that Powell worked for the Treasury, the think tank, and the Federal Reserve, he was closely involved in six financial embarrassments or crises. Each time, there was a question whether the parties involved should take their lumps, to protect against moral hazard in the future, or whether they should be bailed out in order to protect against broader "contagion" or "panic". The essential takeaway from this book is that Powell has faced six such situations in his career and has recommended, advised, or chosen the bailout every time.

In 1991, while Powell was working for the Treasury, a regional bank called the Bank of New England failed as a result of losses in its loan portfolio. At its peak it had been the 18th largest bank in the United States. There was a question whether accounts above the $100,000 FDIC insurance limit should be paid: the classic question of moral hazard versus risk of further runs. In 2013, Powell said, "We came to understand that either the FDIC would protect all of the bank's depositors, without regard to deposit insurance limits, or there would likely be a run on all the money center banks the next morning--the first such run since 1933. We chose the first option, without dissent." As Timiraos puts it, "the fear of a bigger crisis trumped the concern about bailouts."

Then while he was Under Secretary of the Treasury, he oversaw the investigation and sanctioning of Salomon Brothers - and the negotiations with Warren Buffett - after one of its traders submitted false bids for a Treasury securities. And as Powell now says, "Salomon was clearly understood to be outside the safety net, and I recall no discussion of a government rescue. But the firm's failure would almost certainly have caused massive disruption in the markets. To this day, I am grateful that we resolved that crisis with neither a bailout nor a failure." (ibid)

In 2011, Powell was working for the Bipartisan Policy Center think tank for a salary of $1 per year. Although Powell is nominally a Republican, he took a strong stance against Congressional Republicans who were using the Federal debt ceiling as a weapon against the Obama administration: "'So, I feel like I have to say this — there’s only one way forward here, and that is for Congress to raise the debt ceiling so that the United States government can pay all of its obligations when due,' he said at a Feb. 1 press conference. 'Any deviations from that path would be highly risky.'" 

Trump made Powell the chair of the Federal Reserve, replacing Janet Yellen, in February 2018. He immediately began raising interest rates and proposed to shrink the size of the Fed's balance sheet from $4.5 trillion to $2.5-3 trillion. But as we know, the Fed blanched and the balance sheet never even made it under $3.75 trillion. By the fall of 2019, it was expanding again. As was said at the time: "Powell and his Fed aren’t really economic-data dependent. They are market-data dependent — the Fed is afraid that it’s causing the stock market to go down." 

And as Timiraos puts it in the book: "The Fed is an enormously conservative institution, one that rarely changes course as quickly and fundamentally as it did in January 2019. On two fronts - rates and the balance sheet - the Fed had made extraordinary U-turns. These course corrections were even more humbling than normal because they corresponded with what Trump had been loudly demanding."

Powell's fifth and largest bailout (so far...) is of course the pandemic one, hence "trillion dollar triage". The Federal Reserve's balance sheet expanded from $4.15 trillion in early 2020 to almost $9 trillion at the peak in April 2022. The head of the NY Fed's market desk said what was "most frightening" was that "Treasury yields were spiking higher at the same time that equity markets were plummeting." Note that today (July 27th) the S&P was down at the same time the ten year yield was up 15 basis points.

That brings us to Powell's most recent (sixth) bailout in response to the bank failures earlier this year that were caused by losses on Treasury securities and deposit flight, both as a result of higher interest rates. Our thought at the time (1,2) was that a handful of bank failures was all that Powell would have the stomach for, and he would have to give up on using monetary policy to control inflation. The Fed did create an unprecedented new "facility" for bailing out the banks, the Bank Term Funding Program which lends 100% of the par value (not current market value) of U.S. Treasuries, U.S. agency securities, and U.S. agency mortgage-backed securities.

It remains to be seen whether Powell will keep tightening into a deflationary collapse, as the permabears think, or whether he will take what seems like the path of least resistance and go back to expanding the Fed's balance sheet. We should appreciate that Powell's commitment to bailouts has never been tested against conditions of rising inflation. However, interest rates this high will continue to threaten the banks, paralyze the residential housing market, and cause the interest on the federal government's debts to spiral higher. 

And it is the positive feedback elements that make us think that Powell will likely choose bailouts once again. What is the point of tightening if it causes bank failures and federal deficits that just need even more printing to mop up?

Consider also that this decision is not happening in a vacuum. With a year of heavy jawboning and a modest reduction in the size of the Fed's balance sheet, our best measure of inflation has come down close to two percent. Now we are less than a year and a half from a Presidential election. 

The way that you get to be the Fed chair in the first place is if you can be trusted to back bailouts for the rich and to tighten only when politically appropriate. Tightening would certainly never be appropriate if it would cause a populist to get elected (or re-elected) President.

Trump gave Powell an unprecedented amount of public abuse. Also, Trump's base can be fairly described as blue-collar white labor. Capital, as a class, did not like the instability that Trump created during his presidency. Timiraos claims that "every time Trump took a swing at Powell, Powell's inbox exploded with supportive notes from reserve-bank presidents, corporate executives, and Wall Street luminaries."

Our best cynical prediction is that Powell and the Federal Reserve will not tank the economy and the stock market in the final eighteen months before a presidential election. But we would expect stormy weather starting after Biden's second inauguration.

Fed Tightening (April 13, 2022 - March 8, 2023)

We wrote in our Energy - Q4 2022 Earnings Season post that we have been fighting two headwinds for the past year in our investments: tightening by the central bank, and releases of crude oil from the Strategic Petroleum Reserve.

The Federal Reserve began shrinking its balance sheet the week of April 13, 2022, after it had just hit an all time high of $8.96 trillion of assets. (The Federal Reserve prints money to buy the assets that it owns, which are mostly U.S. Treasury and mortgage-backed securities, so the size of the balance sheet essentially reflects the cumulative amount of money printed since the inception of this central bank.)

Prior to the bank failures last week, the size of the balance sheet had been reduced to $8.34 trillion, a reduction of about seven percent. The latest release shows that the assets have started to grow again:

The balance sheet now has $8.64 trillion of total assets. That is a weekly increase of $300 billion, or 3.6%, which means that it retraced half of the total reduction of $600 billion that took almost a year (from April 13, 2022 - March 8, 2023) to accomplish.

We have seen since 2008 that the Fed's attempts to shrink its balance sheet (i.e. "taper") are bearish for risk assets, and that they have been short lived, and also associated with rebounds that are much larger than the amount of reduction. That is why the balance sheet has grown over time and is an order of magnitude larger than it was twenty years ago.

As we wrote over the weekend, it seemed likely that the bank failures of Silicon Valley Bank and Signature Bank (and threatened failures of several other big, important banks) would bring this episode of tightening to an end:

Ultimately, though, it seems unlikely that this will stop until the Fed stops tightening. Continued interest rate increases have been widening the gap between what bank deposits pay and what customers could earn by buying Treasuries directly. At some point, the dam would just burst and deposits would get converted to direct Treasury investments, never to return. Also, higher interest rates have already basically wiped out the equity in commercial real estate (just look at a stock chart of an office REIT like BXP or VNO), and if the rates increase further, these properties will start getting handed back to the banks.

But once the Fed pauses, then no one will think that their bank deposits are at risk because of the interest-rate related decreases in value of assets which are still performing. Banks can then continue to earn their way out of their liquidation value hole, as they had been doing and as has normally happened at various points in past economic cycles.

However, the caveat here is that inflation will come back. They have to give up on trying to get it back down using monetary policy. Maybe they raise taxes, maybe they put a sumptuary goods tax on Ferarris and private jet flights. Maybe they stop printing money to send to Ukraine. There are all kinds of fiscal and regulatory things that could be attempted. Inflation would have been better over the past two years if we had more sawmills and oil refineries and fewer cryptocurrency startups.

We have only one data point to go on, but we seem to have reached the point where the path of least resistance is to go back to printing money. Our cynical view was that it was only a matter of time until they reached this point:

We like ConvexityMaven's theory that the Fed is going to do yield curve control. Instead of letting the bond market crash and taking everything else with it, print money and buy bonds - keep the yields capped. But as the Maven says, in this scenario, "the other side of the balloon gets squishy" - meaning inflation.

If you look around the world, you will notice tons of countries with fiat currencies are running high inflation rates. Meanwhile, deflationary collapses are rare. Can you imagine the central banks of Brazil, Argentina, or Ghana tightening enough to cause a deflationary collapse? It has never happened, because the path of least resistance is inflation.

Betting on inflation is the cynical bet. But we have to be cynical enough to realize that the central bank doesn't want us hoarding real assets and is going to try to trick us with jawboning talk. People will believe the talk and there will be violent selloffs. This is why we like "first class" inflation protected assets and not leveraged junk.

We actually mentioned back in October 2022 that banks would be a casualty from tightening that might force the Fed to stop:

Banks own tons of treasuries, and their balance sheets have been devastated by the increase in the ten year bond yield, something that is being chronicled over at Oddball Stocks. Higher interest rates also mean that the interest on the $31 trillion federal debt grows, which is a positive feedback loop since the debt is not being serviced. And high interest rates choke the economy, which is unpleasant and also lowers tax revenue - worsening the debt spiral - and causes banks' loans to default. So it has seemed clear to us that printing money to buy bonds (yield curve control, capping bond yields) is the path of least resistance, "kick the can" approach that the regime will choose.

This cynicism about the Fed taking the path of least resistance dates back to our "Rethinking Inflation" post from September 2021:

So it starts to seem that the people in this country who make the decisions are not even interested in playing the old deflationary squeeze game because, even if their precarious balance sheets could withstand it, their political Mandate of Heaven probably couldn't. Plus, baby boomer rich are very unlike the old school rich - they do not like seeing things marked down on their net worth spreadsheet. (Every baby boomer has a net worth spreadsheet.) If a big devaluation is going to happen, it would be best to own attractively priced assets that will grow earnings at least as fast as the currency is devaluing. Luckily for us, a major inflationary shock is brewing at the same time that people allocating capital are under the delusion that electric vehicles have "disrupted" oil.

Retracing half of the balance sheet reduction that took a year in only one week is consistent with the results of the previous attempts at tightening.

Note also that Berkshire was buying Occidental Petroleum every day this week while the market (and particularly energy stocks) were crashing.

Cato Journal: "Was the Fed a Good Idea?" & The Eventual Sovereign Debt Crisis

Some highlights from pieces in the Summer 2014 Cato Journal issue, Was the Fed a Good Idea? The first is a piece by Kevin Dowd and Martin Hutchinson, How Should Financial Markets Be Regulated? [pdf]:

Speaking to the UK Parliament's Treasury Select Committee in June 2013, [Andy Haldane] said that the "biggest risk to global financial stability right now" is that posed by inflated government bond markets across the world. He then told astonished British MPs: "Let's be clear... We have intentionally blown the biggest government bond bubble in history."

The same could be said for the policies pursued by the Federal Reserve: the financial system wouldn't be so unstable if the Fed hadn't tried so hard to stabilize it. The Fed's response to the bubbles it has created is to blow even harder and hope for the best. The Fed has got itself into a corner and has no credible strategy to get itself out. We know that the latest bubbles must burst at some point and when they do interest rates are likely to rise sharply as bond market investors attempt to dump their holdings. When that happens the financial system will collapse, again. The temptation will then be to prop up bond prices by monetizing what could well be the entire government debt, at which point the Federal Reserve's balance sheet would explode from $4 trillion to $16 trillion or more almost overnight and inflation will be off to the races. [...]

Zero-Risk Weighting of Sovereign Bonds.
In the original Basel Accord, or Basel I, the debt of OECD governments was assigned a zero risk weight. This implies that all such debt, including Greek government debt, was assumed to be riskless. Its effect was to artificially encourage banks to hold higher levels of government debt than they otherwise would, and was a major contributor to recent EU banking problems. When the Eurozone sovereign debt crisis escalated a couple of years ago, many banks then suffered major and otherwise avoidable losses on their holdings of government debt. This rule has been repeatedly criticized, but is still on the books.

And then a piece by John A. Allison (former CEO of BB&T), Market Discipline Beats Regulatory Discipline [pdf]:

On a related point, there has been a massive failure of mathematical modeling (see Dowd et al. 2011, Dowd and Hutchinson 2013). The Fed’s models failed, and all the large financial institutions that failed were experts at mathematical models. We were told by regulators multiple times that BB&T ought to have models like Wachovia, Citigroup, and Bank of America, all of which had major problems during the correction. Mathematical modeling was forced on the banks and then the banks lulled themselves to sleep believing their models were properly assessing risk, which justified taking excessive risk. What is really ironic is that the Federal Reserve is now forcing all large financial institutions to manage by mathematical models, which will ultimately create significant risk in the financial system.

Modeling can be used as a background tool for managing risk, but overreliance on models leads to dangerous decisions. One of the major problems is that mathematical risk models always assume normal distributions, which have small tails—because if they had "fat" tails no one would pay any attention to the models. Of course, what happens is the tails (the unexpected, extraordinary events) are always bigger than predicted by a normal distribution, and tails are the only events that matter. However, the biggest issue is that mathematical models delude managers into believing they are managing risk and they become overconfident. This overconfidence creates a massive incentive to take too much risk because your models indicate you can manage the risk. Of course, in the long term, if managers take on too much risk, they eventually will pay the price. The Fed now is forcing all large financial institutions to use the same mathematical models, which means all banks are going to make the same mistakes. This same type of approach led to excessive risk taking in the subprime lending business. The concentration of risk created by regulatory mathematical modeling significantly increases the overall financial system’s risk.

As we have been observing over the two years or so, the mistake that this has led to is a consensus to be long Treasuries in the belly of the curve (5-15 year); including banks piling into these Treasury tenors to the tune of several multiples of their equity. Some recent highlights to refresh your memory:

• "[T]he US has a very short maturity structure, so higher interest rates turn into higher debt service quickly. We live on the edge of a run on sovereign debt. The US has a shorter maturity structure than most other countries, and a greater problem of unresolved entitlements. Despite our 'reserve currency' status, we may actually be more vulnerable than the rest of the high-debt, large entitlement western world." [April 2017]
• Ultimately, debt implies a future transfer of purchasing power, and provides only a few choices. Either you raise adequate tax revenue, or you denominate the debt in long-term bonds and devalue them through inflation, or you default, or you violate the social contract made with those who don't hold paper claims (e.g. Social Security beneficiaries) in preference for those who do. Had the borrowing resulted in productive investment, future output would be easily available to meet those claims. Instead, what’s going on is a quiet dilution of future living standards. [December 2016]
• [Y]ou're looking at the endgame of a Ponzi scheme that ended when it caused the total fertility rate, and thus - eventually - the worker retiree ratio, to drop too much. To put in a different perspective, the total equity value of the S&P 500 companies is less than $20 trillion. Imagine the federal government exhausting that much capital in ten years. I don't know when it will happen, but I think the bond market will choke. Occasional spikes in bond yields will be the signal that no more can be borrowed. [December 2016]
• The next crisis is going to come in the investment that is currently perceived as riskless enough for highly leveraged institutions like banks to buy. Right now, government bonds are accorded zero risk in calculating bank capital ratios. The idea that government bonds are riskless when governments are planning to flood the market and when the expenditures are consumed (building no collateral) may prove to be the latest extraordinary popular delusion. This week has illustrated my point. The election of Trump led to an immediate 25 bp increase in the 10 year bond yield, which means an instant 2.3% loss in value. More than a year's worth of interest. [November 2016]
• There could be a period when stocks and bonds go down together. For example, instead of stock declines -> people wanting the security of bonds, people might decide that stock declines lead to bailouts which are really stealth currency devaluations, and decide they want no part of the long end of the yield curve. It is very, very nonlinear, because once bonds lose momentum, who will want to own them? Professional asset management and retail investor sentiment are both all about momentum. And every credit - government or corporate - looks much worse with rising interest expense. I think we will come to realize that a lot of stuff in the economy (junk bonds, private equity) was part of a virtuous interest rate cycle. If you synthesize the best parts of Falkenstein and Redleaf, you predict that the next crisis is going to come in the investment that is currently perceived as riskless enough for highly leveraged institutions like banks to buy. [May 2016]
• We can see with Trump's tax plan (implausible tax cuts and no specific expenditure cuts) that the personalities no longer really matter to the ultimate outcome: sovereign debt crisis, inability to debt finance expenditure, followed by loss of legitimacy of government. [September 2015]
• Having $3 trillion of assets under management puts you in the top handful of asset management firms. Owning $1 trillion of treasury debt (like China or Japan) makes you one of the largest holders. Who, then, is going to be buying the $3 trillion a year that federal, state, and municipal governments are planning to borrow to cover their operational and pension shortfalls? [June 2015]
• For the counterargument that the Fed will just buy bonds to "keep rates low", you have to face the fact that QE invariably caused rates to rise, and you could (and we did) make money buying bonds every time the Fed stopped buying them. As I kept trying to explain, the QE bond purchases may have been respectably large in relation to the flow of debt issuance, but they were puny in relation to the stock of $60T of dollar denominated debt. It freaked creditors out about inflation more than it helped. [May 2015]
• The legitimate purpose of public debt is to borrow money to build infrastructure improvements that have a positive net present value. However, a vast portion of federal expenditure now leaves nothing tangible, leaves no collateral. A treasury bond is a certificate that money has successfully been expended on section 8 housing, or on make-work military "jobs". The lack of collateral makes these treasuries creatures of social mood. In a way, they are as valuable as tulip bulbs or south sea shares. What is a treasury going to yield when mood darkens, and a distressed investor who looks over the enterprise for scrap value is the marginal buyer? [February 2015]

This blog was bullish on Treasuries as far back as 2010, when the "marketable" federal government debt (consisting of securities that traded and excluding intragovernmental holdings) was $8.1 trillion. In March 2017 it is now $14 trillion. Yet the 10 year yield has fallen from 3.3% to 2.3% even as debt/GDP has grown from 53% to 74%.

As the fundamentals of owning government debt have gotten worse, the prospective gain (yield) from owning has fallen! We can see that the federal government deficit is on the order of a trillion dollars per year, since there has been a $6.7 trillion increase in the marketable debt in just under seven years.

Someday when the economy experiences another recession, the debt to GDP ratio will climb faster than it has during this expansion, since three factors will be working to accelerate it: GDP will fall during a recession, lowering the denominator; and debt will increase because tax revenue will fall while at the same time transfer payments will increase.

Meanwhile, despite the booming economy the government debt keeps growing because the federal government runs an enormous deficit. It is politically imperative for whatever party is in power to borrow at low interest rates and maintain spending rather than try to balance the budget. Otherwise that party would be displaced by a different coalition willing to borrow on behalf of its voters. Trump has consistently said that he would grow the national debt, and his ideal budget consists of tax cuts, substantially more spending on defense and infrastructure, and no cuts to entitlement programs. The big drivers of the federal government deficit and therefore the increasing federal debt are the entitlement programs: Social Security, Medicare, and Medicaid. Defense spending is of course enormous but unlike the entitlement spending it does not scale with the growing aged population.

The Congressional Budget Office just predicted that the federal debt will grow by another $10 trillion dollars over the next decade (optimistically projecting the same rate of increase of one trillion dollars per year) to reach $25 trillion by the end of 2027. When George W. Bush took office, the debt was only $3.4 trillion and now the government needs to borrow that much money every two to three years.

It is easy to lose sight of how much wealth these sums represent. There are only about 100 million federal income tax payers in the United States. The current marketable debt is $140,000 per taxpayer and is projected by the CBO to be $250,000 per taxpayer in 10 years. The total equity value of the S&P 500 companies combined is just over $20 trillion. By the CBO's projections, the federal government will need to borrow that much additional capital in under twenty years.

The biggest asset managers like Vanguard and Fidelity each have a few trillion dollars under management. The biggest foreign buyers of treasuries like China or Japan each own about one trillion dollars of U.S. government debt, giving them a certain amount of political leverage. The assets of all the commercial banks in the United States total only $16 trillion dollars. So who is big enough to step up and buy all this government debt year in and year out?

The alternative to borrowing is to get expenses back below revenues. Some think that there are hard limits, like the Laffer curve, to the percentage of GDP that a government can collect, although quite possibly it could collect more than it does now. If so, taxes will be higher, not lower, and disposable incomes and corporate profits will decline. Significant cuts to expenses seem politically infeasible since the largest expenses are these entitlement programs, not discretionary expenses. However, it does not seem as though any serious effort to balance the budget will be made unless and until the bond market, through higher interest rates, forces the issue.

The bond market is often the smartest market and can anticipate an individual company or macroeconomy's fate earlier than equity market investors can.

Note that the 10 year and 30 year bonds have never come close to recovering from the election of Trump.

Perhaps the election of Trump will be end up being totally inconsequential as a historical event, except to inaugurate a new bear market in bonds?

Review of Secrets of the Temple: How the Federal Reserve Runs the Country by William Greider

The one good thing about Secrets of the Temple is the documentation of the Fed's strong influence over the business cycle, and therefore over presidential elections.

Being elected president at or near the top of the business cycle is bad news. When the cost of money eventually spikes and the economy suffers, people blame the incumbent president. This may be why Carter only had one term in office. (Very rare given the powerful incumbent advantage in elections.)

Conversely, Obama was elected at the perfect point in the business cycle: the bottom. He couldn't have had it any easier. The slow recovery actually served him extremely well - where would he have been without the ability to borrow a trillion dollars a year at low interest rates?

Now Trump enters office with very high asset prices - a "big fat bubble". Average hourly earnings are the hottest of the cycle (2.8% growth in December), which gives cover for tightening. It's a safe bet that there's not a single Trump supporter on the Federal Reserve Board of Governors. Raising rates (at the right moment) and causing a recession has a strong chance of defeating an incumbent president after one term.

Think about it, the Fed has three purposes. Bailing out the elite at the bottom of economic cycles, which is a put option that allows them to use more leverage. Choking off the economy when labor is starting to receive a share of economic growth (like now). And third, bouncing populist presidents from office. See this week's WSJ:

"The Federal Reserve is quietly tightening U.S. monetary policy—by means other than interest rates. Decisions made by the Fed years ago mean that the maturity of its $4 trillion-plus bond portfolio declines every day, a process that Fed Chairwoman Janet Yellen said in January has the same impact on benchmark bond yields as two short-term rate increases over the course of 2017. In a footnote to her most-recent speech, Ms. Yellen said that the maturity of the Fed’s portfolio is falling. The average duration of the Fed’s portfolio, excluding mortgage-backed securities, fell to just over six years last week from nearly 7.5 years at the end of 2013"

Unfortunately, this book isn't based on a solid theory of economics (like Austrian), and although it depicts the Fed as a "secretive temple," it does so in a typical journalistic power-adulatory way. The overall message is that the Fed does have enormous power, but it's exercised by and for technocrats and any conspiracy theories are wrong. But watch and see how hard it they are going to make things for Trump.

2/5

Compensation of Employees: Wages and Salary Accruals/Gross Domestic Product

Oh oh, labor share of GDP is getting high. This is the central bank's signal to start a recession.

Money Supply Central Planning

It would be funny to see a retrospective imagining of this kind of breathless coverage and anticipation for Soviet central planning decisions.

"How many pair of boots are they going to make for this winter? 35 million or 45 million? Countdown to People's Central Boot Ministry Decision!"

"High Plateau Drifter" Writes On the Federal Reserve's True Priority: Its Own Survival

Correspondent "High Plateau Drifter" was the author of "Skeptics To the Ramparts" (September 2014) and "Fun On the Permanently High Plateau" (December 2014).

Ok, we all know how steadfast and generous the Fed has been toward stock investors over the past six years. Well, actually, over the past 35 years! And of course we return the love! Yes indeed. And we all know that the Fed can never ever raise interest rates because that would crash the markets. And momma Fed would never abandon us.

Most stock investors seem to think uber-dove Charles Evans proclaiming that “raising interest rates would be a catastrophe” in an unguarded moment on January 8 is an accurate reflection of what Fed heads will actually do, despite all their talk about raising rates sometime in mid year 2015.

Up until recently all of this Fed talk of “normalizing rates” was just talk.

But funny things are beginning to happen as we drift along that permanently high plateau resting on its bedrock of zero percent short term interest rates. In the past, hyperinflations were enabled by the presence of stable currencies in neighboring countries and the lack of currency controls. But with major currencies such as the Yuan, the Euro and many others pegged to the dollar, most capital and wealth in developed and developing countries is fairly complacent. In a U.S. Fed rigged world it is hard to start a serious inflation in any nation with a significant economy.

But with the Swiss Frank suddenly unpegged from the Euro, and with gold now rising along with – and slightly outpacing – the dollar, two very liquid and secure havens seem to have popped up on the horizon. And the negative interest rates in Switzerland or Denmark will allow the European middle class to hoard Swiss or Danish bank notes at zero percent rather than paying for the privilege of depositing their cash in a bank and exposing themselves to “bail in” risk.

Thus, potential convenient inflation hedges are popping up even in Europe. Once oil starts to rise in price the Russian Ruble – an oil backed currency from a country with very little sovereign debt – will offer yet another very attractive alternative.

Of course the biggest threat to the comfort of mother FED's stock market cradle is the new Greek coalition which insists that any bailout that results in more debt is a non-starter. This means that Greek debt is going to be “restructured” which in turn means reduced-defaulted. But then the only way Greece is going to be able to get back on its feet is to repudiate all of its sovereign debt, abandon the Euro and issue the new Drachma. This in turn will mean a massive bailout of European and American banks which under EU rules may consider Greek sovereign bonds as “money good” collateral backing their massive interest rate derivatives, threatening large and fast interest rate moves which produce bank derivative contract defaults. Therein lies the trigger for PIIGS debt repudiation and massive money printing by the ECB or the German and French national banks not in the form of additional bank debt but in outright grants of cash – the fiscal policy trigger for hyper inflation.

There are numerous signs that the Fed is beginning to worry not only that QE is not working as it should to produce growth and prosperity, but that continued QE might go far beyond just damaging its “credibility” and utterly destroy its continued relevance to and power over the markets. In short the FED is beginning to worry about its institutional survival. Failure means that Congress will monkey with the Federal Reserve Acts which grant it power.

Thus the survival of the FED, its power and continued relevance are the top priority right now. The fate of the stock market is a secondary concern. Any investor who fails to see this is dancing with the devil in the pale moonlight.

The FED heads apparently think that if they raise rates just a wee smidge – that in the next crisis they will at least have some interest rate ammo, enough to be invited to the table and thus remain relevant and perhaps rally the markets a bit.

In short, to preserve their institutional power the FED is going to “Volker” your asses!! Well, maybe just an iddy biddy “Volker” that won't hurt too much, they hope!

In my view the debt balloon problem has grown so large that no tweaking by the FED can fix it.

Welcome to life on the “permanently high plateau” and good luck!

This sounds about right to me. All the Federal Reserve can do is tinker with short term interest rates. With short term interest rates at zero at what is looking like a major market top, they have foolishly positioned themselves to be irrelevant in the next crash. In order to continue to claim credit for "rescuing" the market, they need to be able to use their interest rate tinkering tool at a time that is coincident with a market bottom.

The Probability Of Deflation Has Diminished?

The Fed said

"the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year"

Yeah right! Look at a chart of the 30 year yield (down almost 100 bps ytd) or of a commodity index like DBC. Deflation!

What this tells you is that their concern about deflation is situational, conditional. Deflation that threatens the big banks that own the Fed is bad. Deflation that squeezes the proles out of their assets and makes them renters is good.

The big banks have been recapitalized and the proles are making a bit too much money flipping paper [1,2]. Maybe the Fed thinks it's time to pull the rug out from under them?

Removing the inflationary supports in conjunction with a nonsensical propaganda statement is consistent with pulling the rug out. Is it consistent with anything else?

Remember I said four years ago that the Fed was throwing the deflation game? Silver and gold are both significantly lower than when I wrote that post.

The biggest consensus in the market today - by far and away - is that the Fed is just kidding around and will print at the first sign of weakness, and that the printing will take asset prices to new highs. People have staked everything on the conjunction of those two assumptions.

WSJ: "Notable & Quotable: Paul Volcker on central banking and inflation"

In last month's WSJ - this is great.

From an interview with former Federal Reserve chairman Paul Volcker (Class of 1949) in the Daily Princetonian, May 30:

DP: [D]oes high inflation matter as long as it's expected?

PV: It sure does, if the market's stable... The responsibility of the government is to have a stable currency. This kind of stuff that you're being taught at Princeton disturbs me. Your teachers must be telling you that if you've got expected inflation, then everybody adjusts and then it's OK. Is that what they're telling you? Where did the question come from?

DP: Okay. Could you talk a little bit about the justification behind the Volcker Rule and the effect you think it's had on the market?

PV: The rule is that institutions that are protected by the government, implicitly or explicitly, should not be engaged in speculative activities that bear no real relationship to the purposes for which banks are protected. Banks are protected to make loans, they're protected to keep the payments system stable. They're protected so you have a stable place to put your money. That's why banks are protected. They're not protected to engage in speculative activities which led to risk and jeopardized the banking system. That's the basic philosophy. I think it's pretty well-accepted...

DP: Okay. And to get back to the central banking a little bit, given the trade-off between inflation and unemployment—

PV: I don't believe that. That's my answer to that question. That is a scenario and a delusion, which economists have gotten Nobel Prizes twenty years ago to disprove.

I'd love to see Volker reverse QE.

Gary North: "My Translation of Yellen's Speech on Bank Regulation"

He's right that the Fed chairmen, including Yellen, make themselves deliberately difficult to understand. The only funny thing is that he is bearish on treasuries too.

Both Fed supporters and critics are very bearish on treasuries! The one thing they agree on!

Would you believe that Prechter is even bearish on long bonds??

"Fed kicks off global dollar squeeze as Janet Yellen turns hawkish"

Deflation!

"Monetary tightening is coming sooner than the world expected, with sober implications for overheated bourses, and for those in Asia, eastern Europe and Latin America that drank deepest from the draught of dollar liquidity.

We can expect a blistering dollar rally, perhaps akin to the early 1980s or the mid-1990s. It is fortuitous that the BRICS quintet of Brazil, Russia, India, China and South Africa have just launched their $100bn monetary fund to defend each other's currencies. Some of them may need it."

This confirms what Prechter says about the Fed. Inflation is really very modest - a couple percent - and yet Yellen has political pressure from Fed board members to clamp down on inflation already! (Of course, their "Fed put" has caused other problems besides inflation, like egregious misallocation of capital.)

Anyway, just because the Fed could "drop money out of helicopters" doesn't mean they would or will.

"The BRICS, the mini-BRICS and much of global finance have taken out a colossal short position on the US dollar. Mrs Yellen has just issued the first margin call."

Margin, call gentlemen. Hint: if you borrowed dollars to buy assets, you are short the dollar.

"A Broadside Against Bernanke’s Handling of the Great Recession"

This was linked on cheap chalupa blog

"When the central bank utilizes 'lender of last resort' powers to allocate credit to targeted firms and markets, it encourages excessive risk-taking and contributes to financial instability. It also embroils the central bank in distributional politics and jeopardizes the independence that is critical to the central bank's ability to ensure price stability. The lesson to be learned from the expansive use of the Fed's emergency-lending powers in recent decades is that it threatens both financial stability and the Fed's primary mission of ensuring monetary stability."

"The Fed's Rear View Mirror"

Stagflationary Mark:

"The Fed apparently sees and reacts, with nearly crystal clarity, to what has happened 2 years previously. If that is true, then they are just now seeing the booming retail sales growth in January of 2012. No wonder they are tapering. No wonder they are talking about ending ZIRP in 2015. No wonder Bernanke couldn't spot the housing bubble in real time."

Fed Agrees With Us About Deflation

From 2008!

BULLARD: In sum, I think we are moving to a Japanese-style deflationary, zero nominal interest rate, situation at an alarming pace.

Are we crazy for thinking what these people are saying in private, only to release 5 years later?!

It could just as well have been a Credit Bubble Stocks or "Stagflationary Mark" quote!

Bernanke Admitted That QE Isn't What Keeps Bond Yields Low

I didn't notice the speech Bernanke gave last year, called "Why are long-term interest rates so low in the United States and in other major industrial countries?".

"[W]hile central banks certainly play a key role in determining the behavior of long-term interest rates, theirs is only a proximate influence. A more complete explanation of the current low level of rates must take account of the broader economic environment in which central banks are currently operating and of the constraints that that environment places on their policy choices.



Chart 1 shows the 10-year government bond yields for five major industrial countries: Canada, Germany, Japan, the United Kingdom, and the United States. Note that the movements in these yields are quite correlated despite some differences in the economic circumstances and central bank mandates in those countries. Further, with the notable exception of Japan, the levels of the yields have been very similar--indeed, strikingly so, with long-term yields declining over time and currently close to 2 percent in each case.

Bernanke doesn't say it, but the real story here is that if you don't want deflation, you need your population to reproduce. If you have a generation that fails to push the species forward (like the baby boomers, or the low fertility generations in other countries), it seems from the chart above that you can look forward to a grinding deflation no matter what tricks the central banks pull.

Sure, their "easings" and such will cause huge stock market volatility - euphoric rallies and brutal crashes. But notice that they don't have the effects they are supposed to on interest rates. And meanwhile, the inflationists have turned the 10 year treasury into a very crowded short:

Naturally, I think the 10 year treasury is very attractive here.

Speaking of deflation, notice what has been happening to crude oil futures. For example, this is the December 2018 crude oil contract.

The futures market has crude oil declining to $75 and apparently staying there in perpetuity! I wonder, is that supply-side or demand-side?

Similarly, gold keeps declining. There is a long way to go before it hits cost - see for example the Barrick December 2013 investor presentation which shows an average "all in" cost of $660/oz at their five largest mines.

"Why Bankers Created the Fed"

Hilarious quote from Daniel Webster in a letter to Bank of the United States President Nicholas Biddle,

"I believe my retainer has not been renewed or refreshed as usual. If it be wished that my relation to the Bank should be continued, it may be well to send me my usual retainer."

Which was mentioned in this Lew Rockwell article.

Does Social Mood Limit the Fed's Ability to Inflate?

That is basically Prechter's theory. So, even though the Fed "could" completely devalue the currency, that's not the direction that mood is going.

Here is an outline of Philadelphia Fed president Charles Plosser's talk last week at the Cato Institute’s 31st Annual Monetary Conference, "WAS THE FED A GOOD IDEA?" [!]:

"President Charles Plosser discusses what he believes is the Federal Reserve’s essential role and proposes how this institution might be improved to better fulfill that role.
President Plosser proposes four limits on the central bank that would limit discretion and improve outcomes and accountability.

• First, limit the Fed’s monetary policy goals to a narrow mandate in which price stability is the sole, or at least the primary, objective;
• Second, limit the types of assets that the Fed can hold on its balance sheet to Treasury securities;
• Third, limit the Fed’s discretion in monetary policymaking by requiring a systematic, rule-like approach;
• And fourth, limit the boundaries of its lender-of-last-resort credit extension.

These steps would yield a more limited central bank. In doing so, they would help preserve the central bank’s independence, thereby improving the effectiveness of monetary policy, and they would make it easier for the public to hold the Fed accountable for its policy decisions."

Invert that last point: a less limited central bank threatens its own independence! Plosser says that "monetary policy has very limited ability to influence real variables, such as employment," which is something that we know but central bank flaks have long disputed.

He also says that price stability is the only goal that the central bank can ever truly hope to achieve!

Wow! That's deflationary medicine! The timing of Hugh Hendry's capitulation couldn't be any worse, it looks like.

What Bernanke Signaled?

One theory,

"What Bernanke signaled this week is that QE is no longer an emergency government measure, but is now a permanent government program. In exactly the same way that retirement and poverty insurance became permanent government programs in the aftermath of the Great Depression, so now is deflation and growth insurance well on its way to becoming a permanent government program in the aftermath of the Great Recession. The rate of asset purchases may wax and wane in the years to come, and might even be negative for short periods of time, but the program itself will never be unwound."

Interesting.

The Omnipotent Fed Meme is Back

In Barron's

"[F]or the past year, they've been making the case for U.S. equities, but do so now with increased vigor and an interesting take on the news. [...] '[N]ot fighting the Fed has been a successful investment strategy.'"

The omnipotent Fed meme is back. Remind me why we ever have bear markets?

Latest Hussman

This week:

"From an analytical perspective, it’s striking to me that even some thoughtful economists we know have been making assertions about Fed policy that have no basis in the data. For example, we heard last week that 'The number of times we actually had a bear market on our hands with the Fed easing and the economy expanding by any amount is around zero.' Wow. That’s not even true in the 'active Fed' period. Consider for example March-October 2002, when the market plunged 30% despite reductions in the Federal Funds rate and the discount rate, despite positive GDP growth – two quarters into an economic recovery, and despite a Purchasing Managers Index persistently above 50. Ditto for late-2007 when a bear market had already started, the Fed was already easing and the PMI was still above 50 (despite a recession that wouldn’t be recognized until several quarters later)."