We are living in a period of unfamiliar economic times. Over the past several years the US Federal Reserve and other global central banks have taken extraordinary measures to direct the global economy. We all feel the impact of their actions whether we realize it or not. Most of us don’t follow or understand what has and is taking place.
We tend to only pay attention if and when things go wrong.
Following the Great Recession the US Federal Reserve in their own words took “extraordinary measures” to put a floor under home prices and stimulate economic growth. They lowered short-term interest rates to near zero and purchased trillions of dollars of US Treasury bonds and mortgage-backed securities.
They called part of their actions their “portfolio balance channel” strategy. They pushed interest rates, including the yields on safe haven assets such US Treasury bonds so low that yield seeking investors would be forced to take additional risks in order to earn adequate returns.
It was and is an economic experiment on a grand scale.
We are now beginning to see the long-term impact of Federal Reserve’s actions. Some of those impacts seem excellent, others are becoming more and more perplexing and troubling.
Over the last several years the US economy has grown for one of longest periods of uninterrupted economic expansion in history. The stock market has been on a tremendous rip for the last eight years. Home prices have recovered to their pre-crisis level in almost all areas of the country. The unemployment rate is low and job growth has been steady. And, absent student and auto debt, consumers’ balance sheets are in pretty good shape.
On the other hand, while the economy has grown, it has done so at rate well below the long-term average. The national debt has more than doubled. Corporate leverage is at all-time highs. Measures of productivity are suffering. Wages have been stagnant, and real household incomes have actually fallen.
In addition, the wealth gap between upper and lower incomes has widened substantially.
The policy makers at the Federal Reserve are themselves somewhat confounded by current economic trends; most of all inflation which is supposed to rise when the economy grows and unemployment falls.
Current measures of inflation and inflation expectations are falling, not rising.
The Federal Reserve very much wants to raise short-term interest rates and exit their extraordinary measures. They tend to dismiss and ignore the negative issues mentioned above, and they explain away low inflation numbers as being “transitory.”
In a recent press conference, Janet Yellen, the chairwoman of the Federal Reserve went as far as to say that recent low inflation readings were a result of a one-time reduction in cellphone bills.
Really? It was cellphone plans last month, cable TV offers this month, and Amazon groceries next month that will continue to hold inflationary numbers low in the absence of rapid economic and wage growth.
In the view of the author the unfamiliar economic times in which we currently live can be explained in a few simple economic concepts: creative destruction, the efficient allocation of resources, and free market pricing, all of which are related.
You can’t bailout failing companies who have made poor financial decisions. You have to let the financially strong survive and allow new growth lead the way to the future. In economic terms it’s called creative destruction.
Governments can’t pick the winners and losers. As an example, sorry subsidized wind and solar energy, mandated ethanol, and subsidized electric cars, hydraulic fracturing is clobbering you economically. Only the private sector and free market can allocate capital and resources efficiently.
And perhaps most importantly and with the greatest economic impact, the Federal Reserve has created vast price distortions in markets through their “extraordinary measures.” In driving interest rates extraordinarily low they have created large amounts of leverage. Asset prices are distorted. The combination of distorted asset prices and leverage typically doesn’t end well.
In conclusion, something is afoot in our economy and markets. It might unwind slowly, which is certainly the goal of the Federal Reserve, or it could unwind suddenly and in dramatic fashion. One thing is certain, prices, markets, and economies always move toward the free market equilibrium level over longer periods of time.
Barry Nielsen has worked in capital markets for over 20 years with a focus on fixed income portfolio and risk management. He has an MBA from George Mason University and holds the Chartered Financial Analyst designation. He currently works for Opportunity Bank of Montana.
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