Federal Reserve Obsessions Blind Market Pundits to a More Dangerous Truth
A frequent theme of this column concerns how much economists and reporters overstate the power of the Federal Reserve. If the deep thinkers are to be believed, the Fed’s alleged ability when it comes to finding “the neutral real interest rate at which monetary policy is neither accommodative nor restrictive” is the difference between an economy that booms and one that’s recessed. Think about this conceit for a minute, then perhaps think some more.
In thinking, remember that when we borrow money we’re borrowing what money can be exchanged for. The previous truth can’t be repeated enough as a reminder that the assumptions of central bankers and those who follow them are a massive load of nonsense. Implicit in a Fed legend that no central banker or obsequious economist will ever dismiss is that the Fed can plan not just the interest-rate cost of accessing all the world’s resources, but it can also plan through its rate setting how much in the way of resources we market actors ultimately access. Please think about that for a minute….
And after having thought about it, hopefully readers will remember that central planning failed in gruesome, murderous fashion in the 20th century. For good reason. There’s quite simply no way central planners could ever possess even a microscopic fraction of the information necessary to properly steer resource allocation on the way to an abundance of goods and services. Instead, central planning logically led to cruel scarcity. By all accounts, life under central planners was brutal, yet we’re supposed to believe the Fed, for it being staffed with the alleged “best of the best” among economists, can artfully or even semi-artfully set the price of accessing the resources necessary for production, along with that which springs from production: consumption? That’s not serious. Give it time, but sooner rather than later the Fed will be exposed as the paper tiger that it is; an effect of booming economic growth as opposed to a driver of anything. If the Fed were consequential on the subject of credit, the U.S. economy wouldn’t be. Thankfully the Fed’s role in credit allocation continues to shrink with the latter in mind. It’s just not that important.
If anyone doubts this, just imagine the Fed feverishly selling bonds to Palo Alto banks with an eye on shrinking dollar credit in them, only for the same central bank to use those dollars in order to feverishly buy up bonds (thus increasing credit availability) from banks in Appalachia, a stretch of the U.S. that National Review’s Kevin Williamson has described as a “Big White Ghetto, the vast moribund matrix of Wonder Bread,” a “slowly dissipating nebula of poverty and misery with its heart in eastern Kentucky…” It would take the world’s market actors all of a few minutes to correct the previously described error, and the fix would be quick given the immense desire of credit sources to achieve exposure to Silicon Valley. Just the same, the lack of productivity in Kentucky’s Owsley County ensures that the Fed’s creation of abundant “money supply” in a “slowly dissipating nebula of poverty and misery” wouldn’t be there long. Markets are wise, and they relentlessly correct the errors of the State. Hard as it is for economists employed based on the Fed’s supposed omnipotence to accept, the central bank just isn’t that relevant. Thank goodness it isn’t. Central planning always and everywhere fails.
Which brings us to all the hysteria about the stock market, and its recent corrections. Economists and the reporters who enable them are naturally pointing to the Fed’s interest-rate machinations as the driver of equity upheaval, but such a view is less than serious. Not only can the Fed not reasonably limit credit access for U.S. producers in a globalized world of credit as is (see above), the greater truth is that the Fed’s vastly oversold rate machinations were priced long ago. Sorry economists and reporters, but markets never price in the present. Better yet, markets never correct based on the known. Crucial here is that investors have long known that the Fed was intent on moving up the short rate for credit that it laughably aims to influence. Except that it doesn’t. Rates are set by infinite decisions made by billions of individuals every millisecond in the marketplace. Stated simply, the Fed is a rate follower. If the Fed could actually influence rates of interest then it’s certainly true that economic chaos would be the U.S. norm.
Back to the markets, big moves out of nowhere are an effect of surprise. The Fed's actions were the opposite of surprise. Useful here is that seemingly healthy markets started correcting when Vice President Pence made plain that the Trump administration he serves and was speaking for is ready to impose even higher tariffs on China. This was plainly a surprise when we remember how often markets have cheered a reduction or moderation of the anti-trade commentary that’s so often informed the Trump administration’s trade rhetoric. Tariffs by definition tax workers, they by definition harm workers even more for slowing their specialization, and then they harm the companies they’re falsely presumed to protect by shielding them from market realities all the while shrinking the size of foreign markets for them to sell to. Reducing the previous point to what’s basic, American companies sell a lot in China. Tariffs will limit those sales. Just as the shares of Daimler AG (the company that owns Mercedes) would plummet if an earthquake suddenly leveled Beverly Hills, so will U.S. shares correct at any hint that the Trump administration intends to inflict greater damage on a country that represents major sales for U.S. businesses.
After that, consider what the Trump administration followed the Pence speech up with last Wednesday. According to a New York Times report, the Trump administration indicated that “it would more aggressively police foreign investment in the United States, outlining a vigorous review system that is aimed primarily at preventing China from gaining access to sensitive American technology.” According to the Times, Administration sources indicated that it would “review any foreign transaction involving a business that designs or produces technology related to 27 industries, including telecom, semiconductors and computers.” Is it any wonder that investors are uncertain?
For one, foreign investment (including that from China) amounts to precious, always hard to come by liquidity for businesses. Yet the Trump administration, with “national security” as the basis of its actions, will aim to limit this liquidity. Crucial here is that it’s not just the liquidity that investors provide. Frequently they offer know-how, along with advice on how to crack difficult to enter markets. If anyone doubts the previous point, they need only consider what venture capitalists in the U.S. do: their usefulness always extends well beyond finance. Which brings us to arguably the biggest problem with the Trump administration’s actions: they amount to substantial market intervention. The track record of politicians on the subject of presumed national security “threats” is already bad enough, yet the Trump administration wants to add insult to egregious injury with centrally planned foreign investment? Liquidity is liquidity. Just as markets would convulse if Donald Trump aimed to direct the investing of Blackstone, Kleiner Perkins and KKR, so will it correct if his administration aims to control finance that has the temerity to come from overseas. Where’s the outrage from Republicans about this? Apparently Republicans only register their anger with market meddling when it comes care of Democrats.
Markets, on the other hand, aren’t so partisan. Tariffs harm U.S. workers and companies, while government meddling in the crucial area of finance harms everyone. So while logic, reason and market indices will hopefully overpower a Trump administration that’s intent on playing with fire, it’s reasonable to speculate that the recent equity market corrections reflected investor fear that reason might reach the White House later than it should.
