The rationale for low interest rates and QE (money printing) is to achieve a lower unemployment rate and higher inflation. Well according to the recent Federal Open Market Committee (FOMC) they have so far failed to achieve their dual mandate. See the following extract from the FOMC 29-30 October 2013 meeting, with my emphasis added:
‘Although the incoming data suggested that growth in the second half might prove somewhat weaker than many of them had previously anticipated, participants broadly continued to project the pace of economic activity to pick up.
‘Participants generally expected that the data would prove consistent with the Committee’s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in coming months.’
The Federal Reserve acknowledges that growth is weaker, but is still sticking to the line that it will taper. Forever the optimists.
Two senior US Federal Reserve Bank economists, William English and David Wilcox, recently reinforced this message when they addressed the Annual IMF Research Conference. The papers they presented at the conference dealt with life after the Fed tapers – not if but when.
This was a clear signal (as opposed to Bernanke’s rather on/off signal) to the market that the Fed is set to reduce the level of monthly money creation from $85 Billion to a slightly lesser number. Prepping the market for a potential (and I stress potential) change in ‘medication’ is part of the new Janet Yellen communication strategy.
The other message from the Fed was ZIRP (zero interest rate policy) is here to stay until at least 2017. Remember ZIRP was a ‘short term’ measure introduced by the Fed in December 2008 to kick-start the US economy.
This is No Ordinary Recession
Money creation and low interest rates have worked a charm for all post Second World War recessions. But what the Fed and other central bankers (we’ll come to Europe shortly) are finding out is this is no ordinary recession caused by a slump in the business cycle. This is an economic funk caused by a collapse in the credit cycle.
The Great Depression and Japan post-1990 are the only recent examples of a credit cycle slump…and neither of these make for pleasant bedtime reading.
Professor Paul Krugman (the Nobel Laureate economist and the Fed’s mainstream economic cheerleader) argues ZIRP and QE should be maintained because the US is mired in ‘depression’ conditions. The fact Krugman has acknowledged the depressive state of the US economy is a major departure on his previously stated position. Here are some excerpts from his column and my interpretations:
Krugman: ‘…if our (US) economy has a persistent tendency toward depression, we’re going to be living under the looking-glass rules of depression economics – in which virtue is vice and prudence is folly, in which attempts to save more (including attempts to reduce budget deficits) make everyone worse off – for a long time.’
GFW: To me this is The Great Credit Contraction at work. The more the economy and markets deflate, the greater the tendency to save and therefore the depression cycle continues to feed upon itself.
Krugman: ‘…evidence suggests that we have become an economy whose normal state is one of mild depression, whose brief episodes of prosperity occur only thanks to bubbles and unsustainable borrowing…’
GFW: No kidding Sherlock. The longer this goes on, the less mild the depression will be. The authorities creating bubbles based on unsustainable borrowings is not prosperity; it is lunacy.
Krugman: ‘Why might this be happening? One answer could be slowing population growth…’
GFW: Perhaps. But it could also be people have debt fatigue in addition to rising living costs and higher taxes from over-indebted governments.
Krugman: ‘Another important factor [for the mild depression] may be persistent trade deficits…’
GFW: This sounds like a call to arms for the currency war I mentioned last week.
In my opinion The Great Credit Contraction (GCC) has confounded many an economist. Deflating the credit bubble is deflating the economy.
The longer the GCC continues to tighten its grip on the global economy, the more I expect mainstream economic commentators to follow the lead of that other famous economist John Maynard Keynes, when he once said, ‘When the facts change, I change my mind. What do you do, sir?’
Vern Gowdie+
Chairman, Gowdie Family Wealth
