Out of the Box: The Fed and the Way Ahead
“Facts do not cease to exist because they are ignored.”
After the December rabble rousing, by Chairman Powell, I thought he had made a terrible mistake. He agitated the markets, and for no good reason, and caused a lot of havoc in both bonds and equities. Then, for a time, I thought the Fed had finally done a 180-degree flip-flop but I have come to realize that it is more than that.
The Fed has changed games. They used to play “Skip Rope” and then they decided that that game no longer worked, and so they changed to “Jumping Jacks.” Of course, they had a little prompting from the Disney characters as exemplified by “Donald, Duck,” meaning Donald spoke, and they ducked.
The Fed is a funny institution. However, they went about it, they always sang the song of “Independence,” as if they weren’t a part of the government of the United States or as if they were some off-shore institution, and many people bought into this fantasy, and defended the concept. Well, that notion is just ridiculous. The Fed was created by the “Federal Reserve Act” of 1913 and signed into law by President Wilson. They are part of the U.S. government like the Supreme Court or the Department of Agriculture, no different. Yes, they have term limits and a unique structure but that can be amended, or even revoked, at the pleasure of Congress and the President.
Let me be clearer, yes, the Chairman has a four-year term and yes, the Governors and the Presidents have fourteen-year terms and yes, they can make their own independent decisions until, and unless, the Congress decides to change the rules of their existence. The First Bank of the United States was chartered in 1791. A bill to re-charter the bank failed in 1811. Without a centralized banking and credit structure, state banks filled the vacuum, issuing a multitude of paper currencies of questionable value. Congress attempted to solve the country’s financial problems by chartering the Second Bank of the United States in 1816. This second bank lasted until President Andrew Jackson declared it unconstitutional and vetoed its re-charter in 1836.
By 1860, nearly 8,000 state banks operated, each issuing its own paper notes. The need for reliable financing during the Civil War prompted the passage of the National Banking Act in 1863. The legislation created a uniform national currency and permitted only nationally chartered banks to issue bank notes, but it did not create a strong central banking structure. Then, a particularly severe panic took place in 1907 that abated only when a private individual, the financier J.P. Morgan, personally intervened to arrange emergency loans for financial institutions. This episode fueled a reform movement, which prompted Congress to establish the Federal Reserve System in 1913.
Since the creation of the Federal Reserve, other pieces of legislation have shaped the structure, and operation, of the Fed, which is the central bank of the United States. Following the Great Depression, Congress passed the Banking Act of 1935, which established the Federal Open Market Committee (FOMC) as the Fed’s monetary policymaking body. The Federal Reserve Reform Act of 1977 was enacted during a period of surging inflation. It explicitly set price stability as a national policy goal, for the first time. The Full Employment and Balanced Growth Act, approved in 1978, known informally as the Humphrey-Hawkins Act, established full employment as a second goal of monetary policy and required the Fed to report to Congress on its policy twice a year. Most recently, following the severe financial crisis of 2008/2009, Congress passed the Wall Street Reform and Consumer Protection Act of 2010. That law, known as the Dodd-Frank Act, affects the Fed in many ways. It changes the Fed’s governance, increases its transparency, expands its regulatory responsibilities, and transfers most Fed consumer protection responsibilities to a new Consumer Financial Protection Bureau.
Be very clear here, the Federal Reserve Bank is America’s central bank. It is not the world’s central bank and it is supposed to, under its charter, represent the interests of the government of the United States. Therefore, any President, or Senator, or Congressman ,can object to what they are doing and if the objections are strong enough then the Congress can disband the institution.
The crux of the matter now, in my estimation, is that the world’s other major central banks, the European Central Bank, the Swiss Central Bank, the People’s Bank of China and the Bank of Japan have gone off in a very different direction than our central bank. It is not discussed much, but all of those other countries cannot afford their budgets, or their social programs, without the “gig economies” created by their central banks which have flooded a ton of money, a giant “Free Cash Flow,” into their economies with nothing more than a wink, a blink and a nod.
“The truth.” Dumbledore sighed, “It is a beautiful and terrible thing, and should therefore be treated with great caution.”
-J.K. Rowling, Harry Potter and the Sorcerer’s Stone
So, now, for reasons we will actually never know, the American central bank is cozying up to joining the other central banks because our interest rates are so much higher than theirs, and it is causing a serious dislocation. Obviously, also, lower rates help our government as it lowers the country’s borrowing costs along with corporate borrowing, mortgage rates, student loan debt rates and all other forms of borrowing by any person, or institution.
Chairman Powell said yesterday, “The question my colleagues and I are grappling with is whether these uncertainties will continue to weigh on the outlook and thus call for additional policy accommodation,” Powell said, in brief remarks ahead of a moderated discussion at the Council on Foreign Relations in New York. Powell said that “many FOMC participants” judge that the case for somewhat more-accommodative policy has strengthened. Did you expect him to publicly glance at President Trump, or the pending further Quantitative Easing of the ECB? Well, you can just forget about that!
My expectations, when all of the rhetoric has been babbled, and bandied about, is for two rate cuts before the year’s end, and very little actual transparency about the real reasons for them. Chairman Powell uses less “Fedspeak” than many other Chairman, that I have witnessed in my forty-five years in the Great Game, but he still uses some. Perhaps it is a necessary element of the job, but countless strategists and economists have to spend hours trying to figure out what the people at the Fed are actually saying, or meaning, when their tongues are wagging about.
When you can make money from nothing, and you are not held for Federal prosecution, then you own the “Great Game” and the best the rest of us can do is follow along. There are no private institutions on Earth than can compete with these people and each speech, by any one of them, demands virtually all of our attention.
“Men occasionally stumble over the truth, but most of them pick themselves up and hurry off as if nothing ever happened.”
-Winston Spencer Churchill
Mark J. Grant
Chief Global Strategist, Fixed Income
B. Riley FBR Inc.
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