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Confused And Failing Policy Has Led To An Unprecedented Investment Predicament

Powell’s statements about being the next Volcker are absurd.

The essential victory of the Volcker Fed was to restore public confidence in monetary restraint and systematic monetary policy. Volcker did that by reducing the Federal Reserve’s balance sheet to the lowest fraction of nominal GDP in history. It was this restoration of public confidence, not recession per se, that brought down the rate of inflation so sharply.

Over the past decade, the Federal Reserve has wildly abused its “independence,” violating both its 2A mandate and its responsibility for maintaining financial stability, insisting on unprecedented monetary expansion, bringing the ratio of Fed liabilities to both real and nominal GDP to levels never before seen in history, and triggering a decade of yield-seeking speculation that is likely to unwind in tears.

Adhering to 2A is what enables the Federal Reserve to conduct monetary policy without requiring extraordinary measures (such as paying hundreds of billions in interest payments to banks).
John Hussman

The sad truth is that buying $9 trillion in securities not only left the banking industry insolvent, but it now ties the Fed’s hands in terms of fighting inflation.
Chris Whalen

“Billionaire investor Stanley Druckenmiller is betting against the US dollar as his only high-conviction trade in what he believes is the most uncertain environment for markets and the global economy in his 45-year career.
Financial Times

It is the cumulative effect of flawed policies that has brought us to the current predicament.

The Fed has broken out beyond its mandate, and has been rushing into unprecedented and extreme policy action in recent years. Examination of Fed’s policies show just how adrift the Fed has become.

Instability is likely to continue. Investors need to understand the dynamics of the situation to be prepared as events unfold.

The Fed in fact has a single mandate. Section 2A. Monetary policy objectives.

The Board of Governors of the Federal Reserve System and the Federal Open Market Committee shall maintain long run growth of the monetary and credit aggregates commensurate with the economy’s long run potential to increase production, so as to promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates.

However, what does the data really tell us? John Hussman shows the Feds tools are very ineffective in addressing inflation.

On average, how much does the rate of inflation fall in the first year of a recession, as measured by the core personal consumption expenditures (PCE) index? The answer is that it doesn’t. If we examine the change in core PCE inflation strictly from the beginning of a recession to its end, core inflation has not changed at all, on average.

Further, changes in the Fed funds rate have unimpressive correlations with a change in either PCE inflation, or the unemployment rate!
John P. Hussman

Ah! But the Fed now has another tool! Excess Liquidity, or QE.

Former member of the Fed Board of Governors, Sarah Bloom Raskin, giving an excellent description of QE: “You know, view it as, like, an experimental drug that actually is doing some good things, but nobody quite knows how or why at the moment.”
Ronnie Stoeferle

The biggest Fed development has been in Massive infusions of liquidity since 2009.

How has all that excess liquidity helped the economy?

Well, despite the most aggressive monetary expansion in history, total bank lending (business, consumer, real-estate) during the 14-year period from 2008 to 2022 grew at just 3.4% annually, the slowest growth rate in U.S. history since 1947. Similarly, we find no correlation at all between the quantity of excess liquidity produced by the Federal Reserve and the growth of real U.S. GDP over the subsequent two-year period.The same is true for the relationship between excess liquidity and the growth of nonfarm payroll employment over the subsequent two-year period.
John P. Hussman

Volcker was diametrically opposed to this approach

“The truly unique power of a central bank, after all, is the power to create money, and ultimately the power to create is the power to destroy. When I hear complaints about less liquidity, remember there is such a thing as too much liquidity.”
Paul Volker

Furthermore, Volker was dead against wildy excessive and discretionary policy excesses. After the dreamed up extremes in policy in recent years, Powell’s claims that he models himself on Volcker are absurd.

Volcker wasn’t under the delusion that raising interest rates was what would bring inflation under control. Instead, inflation declined because the Volcker Fed restored public confidence that the Fed would exercise restraint and pursue systematic monetary policy.

Increasingly we see that liquidity has none of the intended benefit, but all the unintended consequences.

As the Fed expanded its balance sheet wildly beyond anything reasonably “commensurate” with GDP, it ensured that someone in the economy would have to hold those monetary liabilities. For more than a decade, that money earned zero, provoking the most extreme episode of yield-seeking speculation in U.S. market history. The U.S. banking system now holds $8 trillion in deposits over-and-above the FDIC insurance limit, because the Federal Reserve put them there.

The Fed did not just create the excess liquidity, it added weak bank supervision to the mix.

When you see the exploding quantity of assets classified by commercial banks as “held to maturity,” you’re seeing loose FAS 157 accounting standards in action. Commercial banks now hold $2.8 trillion in held-to-maturity securities. By comparison, total bank capital is $2.2 trillion. Banks, in aggregate, can tolerate a reasonable amount of losses, and of course, classifying assets as held-to-maturity allows those losses to go unreported. Still, none of this quiet Ponzification of the banking system would be necessary if not for a decade of misguided Fed policy.

To add injury to insult the Fed is now in addition, not only insolvent, but losing money as it shells out well over $100 billion to banks for interest on reserves! Tax payers are now on the hook for all this!

The Fed’s handling of the Regional Bank crisis has been very poor. Chairman Powell literally opened his press conference this Wednesday by stating:

 “Good afternoon. Before discussing today’s meeting, let me comment briefly on recent developments in the banking sector. Conditions in that sector have broadly improved since early March and the U.S. banking system is sound and resilient. We will continue to monitor conditions in the sector. We’re committed to learning the right lessons from this episode and will work to prevent events like these from happening again.”

Once again he raised interest rates, and once again within minutes of finishing his speech the Regional Bank stocks collapsed again contradicting his narrative on the Banking system.

The deeper problem is that the health of the economy depends on the health of small business, which is largely financed by the regional banks. The Fed has done a very poor job in addressing this. The details are very well covered by Jim Bianco in this video.

Debt ceiling timing has become acute, as confidence in US credit falls to new lows

The markets are not signalling stability. US sovereign credit default swaps have exploded to new highs. Some resolution will likely be found, but confidence in the outcome is low and recall that the US has defaulted before.

Interest rate uncertainty is also at extremes. The yield curve is showing extreme action unseen for decades. This chart shows the record spreads and volatility between the 3 month and the 2 year interest rate.

Dr Art Laffer puts the current situation in the context of hundreds of years of US economic history, and from that perspective has some choice words on Powell.

Understand the scale of the problem. Here’s Real Estate.

If we combine multi-family and commercial, we can see that the aggregate commercial real estate sector will enter the next recession with 21.4% debt to GDP, the highest amount of leverage ever, well above the entry point of the 2008 recession.

The downcycle is now underway, but its just the beginning.

As we suggested at the beginning of the year, gold has likely begun an uptrend relative to stocks. The big caps have become so distorted that clarity comes from comparing gold to the Russell 2000 where gold remains clearly in an uptrend.


At the heart of this investment predicament is the biggest problem of all. The Fed itself. It has become ever more extreme through entirely discretionary economic theory and choices, unconstrained by historical norms or its stated mandate. The issue of the Fed and policy needs to be addressed, but it’s not just policy that is the problem, it is also personnel, serial misjudgement, and lack of accountability. This is hard to fix and will take a long time to sort out.

More immediately, Investors find themselves with unique challenges and exceptional uncertainty. It is far from clear what the current Fed will do next. In addition, the chart below shows that asset prices have been pumped up by luiqidity to still very high valuations. Currently, passively managed standard portfolios could be in for a very tough decade, of near zero return, based on the expected norms of the last 100 years of history.

It is important to recognize that we are in a period of instability. Make sure you have a robust and flexible process to manage your investments in these uncertain times.

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Raise your accountability, transparency, understanding and control of your investing in real time by having access to this information.

Transform Your Investment Experience

The room for policy manoeuvre, and the stability of the current system should not be taken for granted. Volatility has increased and is likely to continue to stay high. The outlook has rarely been this uncertain. Investment management needs Best Investor metrics and techniques as never before.

Market and economic events are moving fast at this stage. If you need a quick review of the issues that you may need to know about for your own circumstances, schedule a FREE consultation today.

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Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

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