Nobody’s In Control

Nobody’s In Control



Janet Yellen (the Fed's Fairy Godmother)
sez: "Ibitty . . . Bobbity. . . PATIENCE!"
[courtesy Google Images]


Yahoo! Finance recently published “Bove: The Fed won’t dare hike rates this year”.  According to that article,


“Bank analyst Dick Bove—equity research analyst at Rafferty Capital Markets—says the Fed won’t dare raise interest rates with the dollar this strong.”


I agree. Janet Yellen may talk about possibly raising rates sometime this year, but it’s all smoke.  According to Bove:

"Expectations that the Fed will raise rates in September or even June are off the mark. The dollar is simply too strong. It’s having a significant impact on the earnings of international companies across the board and it’s having an impact on the trade balance.”

“If the Fed were to raise rates, Bove believes the downward spiral would be severe. ‘Trade balance would grow more negative, international companies would lose money overseas, jobs would be lost in the U.S. and the growth of the economy in the U.S. would slow down.”  Bove said all those scenarios are just too threatening given the fragile state of the recovery.

“Therefore he thinks the Fed will feel compelled to err on the side of caution and keep rates low.  And Bove added, the Fed never thought it would have to keep rates so low for so long. ‘They thought they could turn interest rates on and off like a water spigot.’”


In fact, the Fed’s predicament may be much worse than an inability to raise interest rates in a fragile economy.  Maybe the Fed has lost its powers to control the economy.  Sure, the Fed still has a capacity to influence the economy—but its powers to control may have vanished.

Interest Rates

Historically, the Fed had two fundamental powers:  1) control the interest rates; and 2) control money supply.

When interest rates were increased, people tended to earn more in bank accounts and would therefore save rather than spend.  Likewise, the additional cost of higher interest rates would tend to discourage borrowing.  Insofar as higher interest rates encouraged people save their currency and stop borrowing, they’d spend less and the economy would slow.

Conversely, by reducing interest rates, the Federal Reserve would discourage savings and encourage borrowing.  People would spend more, and the economy would be “stimulated”.

However, the original concept of raising and lowering interest rates was based on the presumption that most of our physical money (gold and silver) was trapped within the United States by the Atlantic and Pacific oceans.  I.e., if you were rich and had money to loan, you couldn’t easily lend it into foreign markets.  You’d have to load your gold into a chest, trust the chest to an ocean vessel, hope the vessel didn’t sink or succumb to pirates, and hope that no one stole your gold when it arrived in a foreign market.  It wasn’t impossible to lend US gold into foreign markets, but it wasn’t easy.

Therefore, the creditors’ money was figuratively “trapped” within the US.  The Fed could freely lower interest rates on behalf of the consumers/borrowers, and there was little that creditors could do.

In essence, if the Fed reduced interest rates to 1%, the creditors (those who had gold, silver or even paper currency to lend) were caught in a take-it-or-leave-it dilemma.  They could either lend their wealth at 1% into the US economy and earn only 1%—or they could save their wealth and earn no profit whatsoever.

But, once we moved from a physical gold- and silver-based money to a fiat currency made of paper or even electronic digits, the creditors’ wealth could cross the oceans quickly or even at the speed of light.  If the Fed lowered interest rates to say, 1%, creditors were no longer trapped in that “take it or leave it” dilemma. They could simply move their wealth out of the US economy and lend it into whatever foreign country or foreign economy paid the highest interest rates.

With the advent of digital fiat currency and the internet, the Fed lost most of its powers to control the economy by adjusting interest rates.  In the past, if the Fed lowered interest rates, it would “stimulate” the economy.  Today, if the Fed lowers interest rates, it tends to reduce the domestic money supply and thereby slow the economy.

As a result, the magnitude of the Fed’s former power to control interest rates has been often reduced to the status of a mere gesture, and perhaps even lost.

Therefore, today, the Fed’s primary power is to control the money supply.

Money Supply

Historically, if the money supply were increased, it would cause inflation (cheaper, less valuable dollars).  Inflated/devalued dollars would make it more attractive for consumers to spend their savings since, if they left their money in a bank, they would lose value.  Therefore, better to spend a $100 bill now, than save it until its purchasing power fell to $95 or even $90.

Similarly, when the money supply increased, the public was more inclined to borrow and spend currency since they could repay their debts with cheaper/inflated dollars.

By increasing the money supply and causing monetary inflation, people could be prodded to spend savings or even borrow to spend more.  More spending would “stimulate” the economy and help minimize or even avoid recessions and/or depressions.

Conversely, by reducing the money supply, the Federal Reserve would tend to increase (deflate) the fiat dollar’s value.  So long as the dollar’s purchasing power was rising/deflating, people tended to save rather than spend knowing that today’s $100 bill might buy $110 or even $120 worth of goods and services in the foreseeable future.

Likewise, so long as the currency was growing in value (purchasing power) people would be reluctant to borrow currency from banks since they’d have to repay their debts with more valuable, deflated dollars.

As people spent less of their savings and borrowed less freely, spending fell, profits fell, businesses cut costs, and unemployment rose.  Decreasing the money supply reduced the forces of inflation and slowed an economy.


“I Care Not Who Makes the Laws, If I Control the Supply of Money”—Baron Meyer Rothschild

When we had a gold- or silver-based monetary system, interest rates could be easily manipulated by mandate, but the money supply could not.  I.e., the government and/or Federal Reserve could not “spin” more gold or silver coins out of thin air.

The government could reduce the money supply and slow the economy by raising taxes.  But tax increases would not instantly affect the economy.  Tax rates raised today, might not reduce the money supply until next April 15th.

If government wanted to increase the supply of real, physical money, it would have to find additional gold—and that required either hard work and a time delay as miners dug tunnels to search for gold or a war to steal gold from another country.

Given the inability to control the money supply when the money was physical gold or silver, you can see why big government would lust for a fiat currency.  Paper and digital currencies can be produced at almost no cost at any moment in order to increase the apparent money supply, “stimulate” the economy, and give government increased power to control the economy.

Great Recession

Normally, increasing the money supply would cause inflation and stimulate the economy.  Silver might be found in Nevada.  Gold might be found in California.  The supply of physical coins would rise.

However, after the Great Recession began in A.D. 2008, the Federal Reserve pumped most of 3 trillion fiat dollars into at least part of the economy (the big Wall Street banks).  But, so far, that increase in the money supply has caused relatively little inflation or economic stimulus.

Why the $3 trillion addition to the money supply has not yet caused significant inflation and stimulation is unclear.

I suspect the problem might be that the Fed is acting as if the “official” unemployment rate issued by the US government (a little over 5%) is true.  If our unemployment rate is really only 5%, then we’re in pretty good shape and there’s a viable recovery.  Under such circumstances, only a small increase to the money supply or small decrease in the interest rate should be enough to stimulate the economy.

However, if the real unemployment rate—as John Williams (Shadowstats.com) calculates—is about 23%, then the economy isn’t thriving, no recovery is present or in sight, and we’re already ensnared in a full-blown economic depression.  In the midst of a depression, the Fed’s tinkering with interest rates and money supply might simply be too weak to overcome the weight of 23% unemployment.

Whatever the explanation, the fact remains that, for the past seven years, the Fed’s powers to lower the interest rates and increase the money supply have failed to cause enough inflation to stimulate the economy back into a recovery.

Implication?  The Fed’s former powers to inflate the fiat dollar have been blunted and no longer seems to work as expected.

Implication?  The Fed is increasingly impotent and no longer able to control the economy by adjusting interest rates or the money supply.  Instead, the Fed is reduced to influencing the economy by saying (or not saying) magic words like “patience” or “bibbidi-bobbidi-boo!”.

Get that?  Without sufficient power to control the economy, the emperor is nude.  The Federal Reserve can’t control the economy.  Ohh, it can still exert some relatively mild influence, but any pretense of significant control is vanishing.

Implication?  Nobody’s in control.

The US and global economies are something like the Titanic steaming through icy waters without a rudder and praying to God that we don’t hit an iceberg or a black swan.

Nobody’s in control.

If that doesn’t scare you, you be dumb.

The Yahoo!Finance article continues:

“They never anticipated this. It’s a black swan event,” Bove said, meaning the prolonged period of low interest rates is unprecedented and therefore ripples are difficult to predict.”

Bove is right.  The duration of low interest rates is “unprecedented” because lowering interest rates has not yet worked.  (What’s that definition of “insanity”?  Doing the same thing over and over and expecting a different result?)

The Federal Reserve “never anticipated” that both of their fundamental powers (adjusting interest rates and adjusting the money supply) for controlling the economy would fail to work at the same.  It’s like driving down a mountain road when both the foot brake and the emergency brake simultaneously fail.  Whatchoo gonna do?

The Yahoo!Finance article concludes:

“We need to have an accord where central banks come together and make a decision where their currency values should be,” Bove said. “The situation at the present time is not good.”

Oh sure.  We’ll just get all of the world’s central banks to agree to impose global currency controls that will fix the relative value of all fiat currencies at some reasonable level?  We’ll just get all the central banks of the US, EU, Russia, Japan, China, South Africa, Brazil, India, Africa, South America, etc. etc. to sit down some afternoon and agree to fix the value of all of their currencies to levels that don’t unfairly favor one nation or discriminate against another?

Simple!

Why didn’t I think of that?!

In fact, Mr. Bove’s recommendation is a non-starter.  It won’t happen anytime soon.

The emperor is nude.  His former economic controls no longer work as expected.

Janet Yellen admits that her future actions will be based on new “data”.  That means she doesn’t have a plan because she has no powers to implement a plan and no ability to anticipate what’s coming .  She will simply react as best she can to whatever new, unexpected data appear in the future.

Nobody’s in control.

Like a rudderless ship at sea, the economy will continue to coast along, pushed by its mass and momentum to continue in its original direction.  To the casual observation, everything may seem normal.

But, sooner or later, the momentum will dissipate, our ship will slow and then drift randomly with the wind and current.  Eventually, the people will shout, “Oh, my gosh!  The emperor is nude!  Nobody’s in control.”

And that’s when the real trouble starts.