Are you paying attention to the FED?

July 3 2019

A few more nights of sleep and the economic expansion in the US will be the longest expansion ever in the history of the United States. This expansion means, among other things, that a period of lower growth, if not a recession, could only be a matter of time. The natural behaviour of a healthy economy is one of ascending and descending phases, not of everlasting growth. Of course, the American economy has received a massive overdose of all sorts of monetary drugs, such as quantitative easing (QE), long-term 0 percent interest and still receives little benefit, which makes it hard to call it an average economy. This may mean that it takes longer for normal behaviour to be spotted, but sooner or later, this will be the case. Anyone who kicks a ball up in the air will temporarily win from gravity but can’t claim that he has beaten gravity forever.

What are they going to do?

At first glance, the situation seems hopeless. The central banks will soon have to sail in a massive storm with only half a paddle. While looking closer we realize that it turns out to be different. The good news is that the Fed and others can take several measures. The bad news is that all these measures could be harmful in the long run. After all, the bad news is good news for precious metal investors. They are likely to profit from the nonsense that central banks spread.

Lael Brainard is one of the members of the Washington Central Bank’s interest rate committee. Recently she said that she was willing to apply a policy aimed on setting a ceiling for long-term interest rates. The Fed would later announce a fixed top level for long-term interest rates. And decide to act every time the interest rates are threatened to rise above this level.

In that case, the central bank would buy government bonds as long as interest rates would fall below this ceiling again. Alternatively, as Brainard said euphemistically: “There would be no specific obligations with regard to the purchase of government bonds.” This lack of obligations means quantitative easing with no limitations.

Brainard is not alone in her monetary musings. Her colleague Richard Clarida, the second man of the Fed, mentioned the same earlier this year. He wrote in detail about how the Fed could implement this policy last year. Former Fed chairmen Ben Bernanke also wrote about it and academics are now also working on this topic.

James Bullard, president of the regional central bank in the American city of St. Louis, favours the nominal GDP targeting policy. In other words; setting a target for 2 percent inflation per year, but inflation doesn’t go beyond 1 percent within five years for example, forces you to set a higher target inflation then 2 percent to make up for the loss.

So, after five years of 1 percent inflation, the Fed could pursue 5 years of 3 percent inflation. The name of the beast, nominal GDP targeting, doesn’t ring any alarm bells. According to Bullard, nobody would notice, because nobody would understand and spot a difference between inflation targeting and nominal GDP targeting. I want to add; nobody would notice it until the prices start increasing way faster.

The fact that Jerome Powell, the chairman of the Fed, recently said that low inflation is the biggest challenge for the bank, also indicates that the Fed is eager to fuel inflation. The bank wants to create a new policy framework for this.

One of the consequences would be what Lorie Logan, chief of monetary policies at the Central Bank of New York, recently mentioned. The bank would structurally have to buy many more government bonds in the future to drive interest rates in the US. So, it becomes quantitative easing without any financial limitations, but also without a time limit. Those plans aren’t new. There is a country where these plans have been a reality for quite some time.

The Central Bank of Japan has been working on the so-called QQE with YYC policy for years after the bank previously tried out QQE with NIRP. QQE stands for Quantitative and Qualitative Easing, YYC stands for Yield Curve Control, and NIRP stands for Negative Interest Rate Policy. I call it monetary hara-kiri. Get used to those new abbreviations; the chances are that you will read more about these in the future. Investors should keep a close eye on these types of developments. Next month a Fed conference is on the agenda in Chicago, where administrators and academics will discuss new ways to combat recessions. You can assume that they will discuss those abbreviations.

This is not only the case in the US. The top executive of the Swiss Central Bank recently called the negative interest rates crucial to make the franc weaker and thus ensure price stability (curiously enough, that means continually rising prices).

Analysts already state that Mario Draghi’s successor should repeat the promise to do “whatever it takes” on his/her first day. If that doesn’t happen, the markets may panic. That promise, WIT, in fact, the European version of QQE with NIRP and YCC, seems to be internalized at the ECB and becomes a structural policy. Pulling out all the stops to manipulate interest rate markets appears to be the new monetary policy in the West, following Japan.

Speaking of Japan: when negative interest rates and the unlimited buy-up of bonds don’t produce the desired result, the Tokyo Central bank starts to buy shares. The bank has been doing this for some time, making it the largest shareholder in many listed companies. Who knows, the Fed and the ECB might walk the same path.

Long-term investors do well to keep an eye on these kinds of developments, no matter how young, because one thing is sure: if an unexpected sigh from a central banker or a slightly too long pause between two sentences can affect the markets, then it is clear that the new monetary policy will do the same.

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