Kremlinology

Commentators spent the weekend trying to figure out what Janet Yellen’s testimony before the Senate meant for markets. What did she say? What did it mean? Why was she there at all?

“It is important to emphasize that a modification of the [interest-rate] guidance should not be read as indicating that the [Fed] will necessarily increase the target rate in a couple of meetings,” Ms. Yellen told the Senate.

The modification in question was the elimination of the word “patience” in reference to the Fed’s decision to raise short-term interest rates.

Here, we offer a translation: Pssst … the coast is clear.

Photo credit: DPA

Forward Misguidance

The Fed claims to provide “forward guidance” to investors and businesses. By letting us all know what is coming, we are supposed to be able to plan our financial affairs in an orderly fashion. Should we refinance our houses? Should we take on more debt to build a new factory? Would it be better to wait before expecting a price increase?

That is the theory of it. In practice, it is nothing more than tomfoolery mixed with scam. We don’t recall the Fed offering any “forward guidance on the great credit crisis of 2008-09. On the contrary, former Fed chairman Ben Bernanke was offering forward misguidance.

In March 2007, for example, the nation’s top central banker famously claimed that the “impact on the broader economy and financial markets of the problems in the sub-prime market seems likely to be contained.”

And then – after the problems in the sub-prime market not only spilled over, but also put much of the economy underwater – Bernanke offered some “backward guidance.”

He revealed why forward guidance was nothing more than a card trick. The Fed can only react to events, Bernanke explained; it was impossible to see a crisis coming… even when it was one you helped cause yourself.

The central planner magic show.

Image source: clipartlogo.com

Muddles and Mistakes

In truth, the Fed sees only what it wants to see: that its policies are saving the world from sin and sorrow and also from a repeat of the Great Depression. But if, as Bernanke claims, the Fed can see problems only when they’re in the rear-view mirror… and if it can only react to these crises post hoc… how can it know what is coming or what it will do when it gets here?

The classic role of a central bank is to provide liquidity (in the form of reserves) to solvent banks in times of crisis … and to mop up that liquidity after the crisis ends.

There was no question of boosting the value of stocks… or of manipulating interest rates … or of making jobs more available. Those were things free markets, not central planners, were responsible for.

There was no guidance of any sort – forward, backward or neutral. But it’s a whole new show… and the Fed has cast itself in a lead role. It claims the right and the responsibility to make the business of getting and spending more satisfying than it would be in a free economy. This it hasn’t done and cannot do. Every intervention is a muddle and a mistake. The economy suffers the Fed’s help; it does not benefit from it.

It’s easy: just fulfill the five year plan in four years! With central planning, 2+2 can be 5!

Yellen Just Tipped Off Traders …

But interventions have winners and losers. And like a roman à clef, it is to the winners in the box seats that the Fed gives its Oscar-winning performance. They are the ones who gained $8 trillion when the Fed drove up equity prices. And they are the ones who banked the trillions of dollars the Fed stole from savers by way of ultra-low interest rates. And there, front and center, is the financial industry bursting out in lusty applause.

It was to them that the Fed gives its forward guidance… and to them that Madame Yellen whispered, in code, her “all clear” on Capitol Hill last week. Here’s how it works…

The Fed declares an economic emergency. It then nails interest rates to the floor. This allows speculators to borrow at microscopic rates and bet on US stocks, emerging market bonds, Gauguin paintings – you name it.

The risk these speculators face is that they may get caught out when interest rates rise. This is to prevent them from gaming the system (taking the Fed’s cheap money and running up stocks, for example). Take out the dread of an unexpected rise in carry costs, and speculators can run wild.

Forward guidance is just a way to tip off the traders before the cops show up.

Effective federal funds rate, log chart (otherwise you wouldn’t be able to see it) – via Saint Louis Ferderal Reserve Research