Daily Comment – 10th December 2009: The Fed is the Problem

Macro

The Fed is the Problem

Last night I didn’t get as much time as I normally do to digest my economic reading so today I’ll “link you through” some of my reading.

Let’s start with the remarks I made yesterday; there were a few strong words, most notably my comments on the virtuous circle of debt and the “reason central banks have difficulty controlling this Moral Hazard is because they are the Moral Hazard – they are an integral part of the debt cycle.”

A bit inflammatory, you might think, but I’m not the only one with this opinion, indeed I’m considered conservative in many circles – everybody knows Roach’s opinion on the central bankers of our era and Jim Rogers thinks that the Fed should be abolished. However, it just seems to me that there is a growing chorus of recognition here that the Fed’s policies may indeed be a more significant part of the problem than was at first thought. This is not a jibe at any person in particular (you all know where my sentiments lie anyway) but, rather, at the institution as a whole. It’s a subtle, yet hugely significant shift in sentiment. I may be completely off the mark with this but I was reading a couple of blogs (the best place to look for undercurrent themes) and I began to wonder. Andy Sutton of Sutton Associates is a man after my own heart, in his piece Bernanke Is Not the Problem he speaks directly to the heart of the matter in. In his opening paragraph, he too argues that over generations of misalignment, the Fed has had a pivotal role in debasing policy from economic reality:

“As much as I disapprove of Bernanke’s policies and his handling of virtually every aspect of what has gone on, I’ll be the first to admit that Big Ben isn’t the problem. No, it isn’t him or Greenspan, or Volcker. It’s the institution itself that is the problem.”

In this well laid out argument it’s the first section which catches my eye. So much I’m simply going to cut and paste it as a quote [emphasis, mine].

Mandate #1 – Price Stability

When the private Federal Reserve was chartered in 1913 by the unconstitutional Act of the same name, it stated two specific mandates: maximum employment and price stability. Those were to be the Fed’s areas of activity. However, with virtually no accountability to the American people (except vis a vis the President who appoints the Chairman and the Congress who invariably rubber-stamps such appointments), the Fed was turned loose on the undefended US Dollar.

[For years, the American public has been duped into thinking that inflation is necessary for economic growth]. This outright lie will likely compete for the title of biggest financial fraud in history. Aided by this unawareness, we have seen a fairly standard 5% rate of annual inflation institutionalized into our economic system. For quite a while, this inflation went virtually undetected as it feasted mainly on the prosperity America had achieved, particularly after the Great Depression. As a nation, we began to spend away our surpluses and attach claims on future economic activity through the great society programs of the 1960’s and the perpetuation of New Deal programs such as Social Security.

By the 1970s, however, we’d run short of real money and dealt the global financial system the shock of accepting paper dollars in settlement of our out of control deficit spending. This resulted in a period of increased instability in the 1970s and twin severe recessions. By this time, the devalued Dollar had destroyed enough of our purchasing power that it became necessary in many cases for a second breadwinner to work to maintain the standard of living. In the 1980s and 1990s, Americans began to rely increasingly on consumer credit to bridge the gap left by the waning dollar, and for much of the first decade of this new century, the house became the ATM as another gap filler.

It is no wonder that the recent contraction in consumer credit isn’t touched by the mainstream press; it is that critical to economic growth. This contraction is one of the biggest reasons the federal government has stepped in with record deficit spending. To keep the economic charade going, it has had to.

The above bevy of charts and data should make it perfectly clear that the Fed has failed in spectacular fashion in terms of price stability. The only thing it has been successful in is ensuring that the devaluation of the Dollar occurred gradually, over time, so as not to alarm Main Street.

Amen, Andy, Amen. Keep that last chart on consumer credit imprinted on your brain.

Andy isn’t the only man on this train; with less visual impact, another undercurrent blog writer, Ray Long of CopperMillions makes an equally compelling argument on the role of the Fed and phony inflation numbers again [emphasis mine].

This emphasis of interpreting inflation thus has blunted its original meaning, and in the process obscures the cause of rising prices. The current administration is promulgating nearly limitless monetary expansion, as a devalued currency makes it easier to service the egregious national debt. [The FED is readily assisting this misguided policy. This is an invisible form of taxation, as every fiat dollar held by consumers is diluted in value and is eroded in purchasing power].

Such a tsunami of currency creation will result in huge hikes in cost, of virtually everything we need for daily life. It will result in eventual hyperinflation, to the great detriment of all. But rather than point out the adverse consequences, politicos – like magicians – use what is essentially propaganda to misdirect constituents ire. Instead of admitting that they are the cause of rising prices by increasing the money supply, they will point at the price of a barrel of crude.

Since the creation of the FED in 1913, the dollar has lost 95% of it’s purchasing power. This is based on the numbers the government provides, and may in fact be worse than that. The CPI -the Consumer Price Index – is a measure of the cost of goods purchased by an average household in the United States. Calculated by the U.S. government’s Bureau of Labor Statistics, it is heralded as an accurate means to measure inflation (i.e rising prices).

[But the CPI is replete with flaws which result in a product which intentionally understates true inflation]. During the Clinton administration, the methodology used to examine inflation began to rapidly mutate, transforming into a system which bears small resemblance to the original. John Williams of ShadowStats.com states “the problem lies in biased and often-manipulated government reporting.” He provides proof that annual inflation is understated by roughly 7%.

This understatement of inflation, which began during the late Carter and early Reagan administrations, works to the benefit of the government. Cost of living adjustments to government pensioners, and social security benefits to all who receive them, have been gutted. Like a Saracen wielding a scimitar against some hapless Crusader, payments have been cut in half from what they should be. GDP is artificially higher. Blame is dodged by those responsible for faulty fiscal policies.

Lastly, I remember inferring a few days ago that there may be a latent deflationary creep infecting our psychology. We know the secular deflationists like Rosenberg still stick to their mantra but a few of the side-liner appear to be leaning this way too. Mauldin abandoned his “Muddle Through” middle line, Meredith Whitney lurched back into bear territory like a chocolate addict in a candy shop, after abandoning her (exceptionally well-timed) bullish trading call on financials.

Now remember I said to keep that chart of credit contraction in your mind? Watch Meredith’s expression when she talks about the consumer and credit contraction: here #1 and here #2. Listen out for the quote in link #2, after about 3min 30sec (referring to credit contraction):

“what’s so politically volatile and makes Washington nervous right now is that you’ve never had that happen ever before”.

A little more worryingly, I notice a little deflationary defeatism in these two words: “significant” and “headwinds”. That’s right, coming from the Federal Reserve Chairman Ben Bernanke, no less. Fear not Gentle Ben, as Faber remarks, the Dollar is the World’s reserve denomination you can always induce inflation by obliterating your currency. Copper touched a new high last week, perhaps for good reason?

Macro Data to Watch:

• Aussie Jobs came out better than expected putting unemployment rate at 5.7%
• Japanese Inflation Numbers came out (+0.1% vs -0.2% est)
• Japanese Machine Orders came out roughly in line (4.5% vs -4.4% est)
• Italian GDP
• BoE Announces Rates
• French Manufacturing and Industrial Production
• US Jobs Data

Markets

Well, as I mentioned copper I feel I should include it as my chart of the day. There you go – pretty strong trend I would say, wouldn’t you?

Source: Bloomberg

S&P had a small rebound but nothing substantial enough to put the rally trend back on track. Stocks have been range trading for a while now, perhaps a little nervousness coming into year-end profit taking, perhaps Meredith Whitney is right about the financials and sentiment on Main Street.

Global Stocks to Watch:

• I think the financials have it again today – with most concerns surrounding the financial sector (be it Greece, Dubai, Consumer Credit or Darling’s Taxation on Bank Bonuses. See ING stock keeps getting pummeled – down 43% in just two months (ouch!)
• Costco out with earnings today (odd timing, I have to admit)

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