Fed Diligently Fails to Notice Impending Crisis
NEW YORK – February 22, 2019
The Federal Reserve recently hinted that it is not going to raise interest rates at the moment and may even stop the post-crisis reduction in its balance sheet earlier than expected.
However, giving a positive assessment of the American economy, Fed Chairman Jerome Powell continues the sad tradition established by his predecessors Alan Greenspan and Ben Bernanke. This tradition is called “a lack of connection with the real economy.”
Take a closer look and you will see that this is so. Moreover, this is not just blindness, but a deliberate ignoring of a large number of signals about an impending recession, including a sharp slowdown in housing construction, stagnation of car sales, a decline in retail sales, and an economic slowdown in China and Europe. And all this is accompanied by a reluctance to listen to those who warn of the imminent crisis, writes economist Avi Temkin in Barron’s.
When we read transcripts of Fed discussions on the eve of megacrises, such as in 2000 (Greenspan) or in 2008 (Bernanke), and analyze Powell’s statements last year, it’s hard to understand why the Fed didn’t see the real state of the economy and didn’t take urgent steps. Only after reality hit hard and the ship crashed into an iceberg was there a willingness to recognize analytical shortcomings and erroneous statements and there were changes in politics.
To be fair, it must be admitted that on the eve of the recession of 2001 and the financial crisis of 2008, not only the Fed, but leading bankers and economic forecasters were misled. In December 2000, at a meeting of the Federal Open Market Committee (FOMC), Greenspan ridiculed the high-tech industry, saying that managers’ concerns about reducing orders and demand for products are in fact only alarming about the value of their companies' shares and their personal wealth. All participants of the meeting then laughed out loud.
Two weeks later, during a conference call between meetings, the FOMC unexpectedly announced a 50 basis point reduction in the federal funds rate.
The Fed, led by Greenspan, began raising rates in 2004, and Bernanke, who replaced Greenspan in 2006, continued this policy. He raised the rate three more times, or until it became clear in mid-2007 that something terrible was happening on the subprime debt market. Nevertheless, Bernanke then declared that any crisis would be limited and would not have a negative impact on the entire economy. After he refused to cut the rate at the FOMC meeting in August 2007, he was reportedly praised by the former US Treasury Secretary Robert Rubin, who was the chairman of Citigroup then, for the correct actions,.
A few months ago, Powell said that the current economic cycle in the US could continue indefinitely. He called the economic outlook as positive as never before and pointed out that the rate is "far" from the neutral level at which the economy is in equilibrium. At that time, large investment banks and several well-known hedge fund managers predicted a rate hike to 3.5%, as well as a rise in long-term bond yields to 5%. The US economy "works to its fullest," then declared the expert of the Milken Institute.
However, while the Fed and others claimed that the economy was in excellent shape, there were already more than enough signs of stress. The Chinese Shanghai Composite returned to its 2006 level. The Japanese Government Pension Investment Fund, the world's largest state pension fund, announced a loss of $ 135 billion. Europe's economy also had little to rejoice about.
Today in the US, corporate profit growth is slowing, and share repurchase (until recently, the main source of support for the stock market) is declining, due to the fact that funding is becoming more expensive or even disappeared. The repatriation of corporate funds in connection with changes in tax legislation helped finance the repurchase in 2018; this year it is no longer at the same level.
The buyback was also funded by low-cost debt, of which about $3 trillion was issued in the last five years and is now on the balance sheet of companies. The recession will significantly reduce the willingness of companies to authorize additional aggressive repurchase schemes. At the same time, the Fed is reducing its balance sheet by $50 billion a month, which reduces the liquidity of the financial system.
It is clear that the global economy is slipping into recession. And if the authorities do not take unprecedented steps, the crisis may turn out to be even larger, covering China, Europe, emerging markets and other troubled economies. The Baltic Dry Index, which has fallen sharply since mid-2018, eloquently speaks of a decline in world trade and exports. The US trade dispute with China only aggravates the problems.
Central banks ultimately responded to the latest crisis by lowering interest rates to zero or lower, which increased asset prices, stimulated savings, and pushed economic growth. However, ultra-low rates caused damage to insurance companies and pension funds, which were not able to get sufficient investment returns. Despite the fact that in recent years, interest rates have slightly increased, central banks have too few tools left to deal with another global crisis. Ultimately, they will have to change policies and resume quantitative easing.
We shouldn’t forget the growing social and political tensions all around the world. The only effective measure to prevent a crisis can be a sharp increase in government spending and tax incentives. But making the government a solution for all economic crises is a dangerous step that not only threatens asset prices, but also hastens the sad end of capitalism.