All Eyes Are On the Fed, And That's the Problem
To read the financial and economic commentariat right now is to know that all eyes are on the Federal Reserve. Will it or won't it cease buying Treasuries and agency paper, will it or won't it raise the rate it sets for short-term credit? If the pundits are to be believed, such information will impact the allocation of trillions of dollars worth of investment.
Walter Bagehot long ago wrote that central banks attract ‘vain' and ‘grasping' men, and if readers wonder why, look no further than all the attention the Fed is receiving this week. Simply put, the thoughts and decisions of the charitably average people who populate our central bank are constantly scrutinized with great care by the sharpest financial minds on earth.
It's heady stuff, it explains with great ease why Ben Bernanke so publicly lusted to fill Alan Greenspan's chair, but it also speaks volumes about why our economy remains rather limp. Indeed, the allocation of global capital hinges on the thoughts and actions of people who are regularly wrong. By definition.
As the Wall Street Journal's Jon Hilsenrath and Phil Izzo noted on Monday, "In every year of the economic recovery, the Federal Reserve has overestimated how fast the economy would grow." Some might respond that Hilsenrath and Izzo are nitpicking, that the world's foremost central bankers are being judged on a small sampling of numbers, but then John Allison was Chairman of BB&T Bank for 20 years up to 2009. Writing about the Fed in his essential book, The Financial Crisis and the Free Market Cure, Allison observed that "In my career, the Fed has a 100 percent error rate in predicting and reacting to important economic turns."
Think about the above. The dollar's price is the most important in the world, and then the price of credit is a close second. All that in mind, the very central bank broadly known to always be erroneous in its economic forecasts is charged with setting the short rate for credit, its machinations unnaturally distort the value of the dollar, and then in these modern times this same Fed has decided that it must fiddle with various monetary aggregates in order to steer the economy out of its slump. Is it any wonder that the very economy the Fed hubristically presumes to fix is still slumping?
The logical answer is no. Economies are simply a collection of individuals, individuals make errors, and because they do, the speediest cure is to let their mistakes run their course. Recessions are a happy sign that individual errors are being corrected, and for being corrected, signal a powerful rebound ahead. That is, if we allow recessions to quickly work their magic.
In this instance we haven't, and our Bernanke-led central bank has factored prominently in the federal government's decision to smother the economic patient with intervention meant to soften the near-term pain of a downturn. The self-proclaimed foremost expert on the Great Depression has apparently learned all the wrong lessons from it. The Depression wasn't ‘Great' because a compassion-free federal government wasn't activist enough in attempting to blunt the effects of recession, rather it was long and painful precisely because politicians and economists went to extra-constitutional lengths to shield us from a quick recessionary cure.
Looking at today's struggles, it's widely agreed that the driver of our difficulties in 2008 was a rush toward housing consumption in the years leading up to the market correction. So while the '08 correction was surely exacerbated by government intervention, the broad message of it was healthy; as in too much credit had migrated toward the housing space. Despite the clarity of the market's message, the supposedly wise minds at our central bank chose to aggressively double down on the very capital allocations that initially forced us into a deep economic ditch.
Commentators and investment strategists who should know better talk and write about a stock market that's ‘addicted to the Fed's QE' and that is propped up by the same central bank's ‘money printing,' but the greater truth is that the Fed's machinations have served as a massive barrier to a true bull market. That QE is a barrier makes logical sense for it promoting more in the way of housing consumption, not to mention that it's explicit in its devaluation of the very dollar income streams that lure investors into the marketplace to begin with.
The mechanical argument against QE is equally strong. Implicit in the adolescent suggestion that the Fed's creation of dollars is the driver of market highs first reached in 2000 (when the dollar was much stronger) is that excess dollars have been seeking a home, and the stock market has opened its doors. It's a nice thought until we stop and remind ourselves that for a buyer to enter the market, there must be a seller exiting. In short, any dumb money presumed to have joined the latest rally has by definition replaced other, perhaps smarter money that's departed.
So the pundits say ‘all eyes are on the Fed,' but lost on those same pundits is just how problematic are their pronouncements. That it's true is the strongest signal yet that our central bank has become far too powerful, and in becoming that way, has morphed into an economic hindrance. An entity that's full of mediocre economic analysts such that its forecasts are consistently wrong has so insinuated itself into the marketplace that the world's greatest financial minds must observe its actions and parse its words with greater and greater care.
Rather than judge companies on their individual merits, investors must waste valuable time playing junior Kremlinologist in order to divine the future actions of the second rate economists who populate the Federal Reserve. Investors aren't doing this because our central bankers have any useful knowledge to impart, but because what should be a low-entropy monetary input has become a high-entropy, bull-in-the-China-shop distortion whose actions must be priced.
Far from a driver of positive economic evolution, a Fed that we all have our eyes on has become an economy-shrinking distraction that forces us to consider the macro over the all-important micro. Instead of focusing all of our attention on commercial ideas not yet hatched but that need investment, on existing companies that simply need new direction, not to mention healthy companies that would grow even larger and healthier if entrusted with more funds, investors must, in the words of George Gilder, spend inordinate amounts of time so that they can "predict the exercise of government power" over predicting which technology highflyer will become the next Apple, or which corporation is best suited to cure cancer.
In the ‘80s and ‘90s when dollar stability reigned the economy happily evolved into one of the mind, and growth soared. But thanks to an ever intrusive central bank (its intrusive nature not coincidentally occurring alongside slower growth), we're now a non-market economy driven by knowledge of what's inside the minds of highly fallible individuals, as opposed to understanding the minds of the CEOs of our best companies. All eyes are on the Fed today, and that's certainly the problem.