The Perpetuity of Change: An Analysis of the Federal Reserve System

A lot has happened in the world since I last wrote.

Enough to where I had trouble picking a blog topic.

Do I talk about the dollar?

Or do I talk about the devilish decline in the DJIA, that has people running for the hills?

Or do I talk about the meltdown in the crypto market?

The inversion of the yield curve?

The exponential movement in volatility?

Honestly, all of these are ideas intriguing. All of it could be incredible content. But as I started my research, I realized that I would be writing the exact same underlying message for each potential topic.

It’s a message that reverberates in my mind whenever I read articles on the markets, on the government, on anything nowadays. I think about it a lot. And it frustrates me.

Something is not working.

Something is fundamentally askew with how things are functioning.

To pretend I knew how to fix it would be a complete falsity.

But as I watch the world freak out because the market is doing what it is supposed to do, what is healthy for it to do, I get worried. When I see the value of the dollar swing because our politicians say two opposite things on consecutive days, because it is a fiat currency backed but nothing but faith in a government, I get worried. When I see interest rates remain near zero for eight years, I get worried.

I hate to sound like a broken record, because I feel as though my blogs recently have just been harping on the fact that we have some issues at hand.

I hate negativitity.

But I dislike the current trajectory of our economy even more.

After all, “There is nothing perpetual but change” according to Mises.

And something has to change.

The Federal Reserve

Central banking.

We’ve had a semblance of it since Washington implemented Alexander Hamilton’s bank design in 1791. The idea was controversial, as there was no clause in the Constitution allowing a centralized corporation to carry out monetary policy. But it carried through.

Despite this, many different Presidents have opposed the idea of a central bank. Andrew Garfield stated ” “Whoever controls the money of a nation, controls that nation and is absolute master of all industry and commerce. When you realize that the entire system is very easily controlled, one way or another, by a few powerful men at the top, you will not have to be told how periods of inflation and depression originate.”

Basically, the central bank is an overuse of power. There’s always been a glimmer of discontent with how the Federal Reserve works (there’s discontent with everything) but I think that the premise on what the institution itself stands on is concerning. Control of money. When you control the money, you control the world.

As Dr. Daniel Cloud, philosopher and author of  The Lily: Evolution, Play and the Power of a Free Society writes Planned markets are sick markets… always in crisis, because their most-important social function — facilitating selection between competing pools of capital on the basis of what way of doing things in the real world works best in practice…— has been disrupted by the planner’s clumsy interference.”

Dr. Cloud summarizes the issue at hand well. Central banks have been pedal to the metal since the Recession. Low interest rates. Quantitative easing. Capital pumping. They are convincing the public that low-interest rates and a booming stock market are normal.

There is nothing normal about an artificially monetary system that is dangerously intertwined with the global economy.

In an excellent article on Zero Hedge, Mark Spitznagel, a hedge fund manager at Universa Investments broke things down in a very tangible way.

He began the discussion with the statement below: (comments in red are my own)

This is an age of massive artificial economic imbalances and systemic risks. You can only defer (change), not stop it. (Juxtapose this view with outgoing U.S. Federal Reserve Chair Janet Yellen’s ambitious claim that there will not be another financial crisis “in our lifetimes.”) When we try enforcing stability by decree, a reckoning always follows. An unsustainable boom leads headlong to an inevitable bust. A hard rain falls.”

Basically, the Fed (and the government) has been kicking the can down the road for a long time. They have blown up the economy to astronomical, overvalued proportions.

He continues: “Rather than fear it, we should “tell it and think it and speak it and breathe it.”… Something really big is coming. Let the central bankers try to keep standing in its way, but as investors we need to recognize and accept its logical consequence of a return to the meaning of volatility.”

We need to realize that the market can’t go up forever. And that’s not a bad thing. No growth, not even economic growth, can be linear.

think of the landscape of problems we have – think of the over-valuations we have, look at where rates are, there’s no room for more monetary-easing… – It’s easy not to worry about that but everything is distorted today – this is what happens when we have the type of historic monetary interventionism that we have had.” 

And then back to the Central Banks. We have had too much quantitative easing, too much rate manipulation, and too much involvement.

The Central Bank is losing the power that it once had. As evidenced below.

Market Correction

On February 2nd 2018, the market began to fall.

Market Drop

Image via Zero Hedge

A down movement of more than 10%. There have been 16 movements like these since 1976. Goldman’s Chief Equity Strategist, David Kostin, made the point that only 30% of these 16 movements resulted in a recession. One that occurred in 1987, resulted in a bear market. The other 10 movements were uneventful, resulting in normalcy.

For these movements, it takes “70 days to trough and 88 days to recover” according to equity research.

On February 5th, 2018, the market had the worst point decline in history, dropping almost 1,600 points.

VIX, a measure of volatility shot through the roof that same day by 116%. (This is a whole other issue that I am going to save for another blog)

I think there have been a few warning signals for this correction.

  1. Interest rates
    • As I mentioned you cannot have artificially low-interest rates for 8 years. You just can’t. It results in an extended credit economy, and wipes out the ability to fight inflation
  2. Inflation
    • I don’t understand the forces at play here. How can we have drastically low inflation, below the Fed’s goal of 2% but have extreme debt and rapid increases in the money supply?
  3. Valuations
    • The overvaluation of the market compared to real economic growth. It just doesn’t match up.

Bitcoin

To bring this piece full circle, I am going to bring in Bitcoin.

Oh yeah. Cryptocurrency.

To keep it short and sweet, the coins have tanked over the past couple weeks, with Bitcoin hovering right around $8,500, well off its high of $20k in December.

bitcoin

Image via How Much

The premise of Bitcoin is on the basis of what the Fed has done with artificially suppressing rates and the asset purchases.

People got sick of it. People are disenfranchised.

So they speculated. And some people lost a lot of money. I won’t even pretend to understand the intricacies of crypto. But the basic idea, is that Bitcoin exists, because of the actions of the Federal Reserve and the central banking system.

Conclusion

At the beginning of the article, I talked about how there was a central theme to all the topics I wanted to discuss. As I uncovered big truths and little truths, I realized that there was a root to all of them.

The Central Bank. 

The reason the market corrected in the beginning of February “besides the fear of faster inflation and interest-rate increases, (was that) more robust wage gains could eat into record-high corporate profits.”

Wage inflation. Signal to raise rates.

But the drop we had on February 2nd. Signal to lower rates.

The Fed is stuck between a rock and a hard place. People are starting to realize that things aren’t adding up. That the market cannot be at all time highs when the economy is stagnant. That inflation really cannot be low when all the Fed does is pump money into the market.

That’s why cryptocurrency is a movement. It’s a dissent against the centralized power. But we have to have more than just speculation in that market for it to be successful. There has to be a tangible way to define success, and a real value tied to the coins.

Milton Friedman is a very well-known economist. In his 1982 book Capitalism and Freedom, he wrote “Only a crisis – actual or perceived – produces real change. When that crisis occurs, the actions that are taken depend on the ideas that are lying around. That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.”

Something has to change.

I think we need to switch from the monetary stimulus we are using. We need a normalization of rates. And we need a hands-off approach to allow the market to do what it naturally does.

fed.jpg

Image via Global MacroMonitor

Disclaimer: These views are not investment advice, and should not be interpreted as such. These views are my own, and do not represent my employer. Trading has risk. Big risk. Make sure that you can balance your risk/reward, and trade small, and trade often.

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