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It's Not The Economy Stupid: It's The Fed

Submitted by Mark St.Cyr,

Back in the early 90’s during that era’s presidential campaign James Carville coined the narrative “It’s the economy stupid!” as to have his operatives rally around and focus their attention in a singular direction. Not only was it a brilliant strategic meme, it continually gave clarity to near everyone as to exactly what was “the” problem affecting everything.

Regardless of one’s party affiliation, discounting the simplicity and power contained within that simple line is to do so at one’s peril. For we remember it today decades (yes decades!) later because of its simplistic brilliance and effectiveness. During that period – if you weren’t talking and answering questions that were economy specific – nobody listened, nor cared. It was all about jobs, wages, GDP growth, etc., etc.

Today many are talking about the economy, but that’s all they’re doing: talking. Doesn’t matter if its today’s politician, CEO’s from the largest corporations, some national or regional business association figure-head, right down to academia with its self-perpetuating gaggle of Ivory Tower economic aficionados. All they are doing is paying lip-service to the problems. And the reason? They can’t do anything about it because as of today, the U.S. economy is being controlled high-handedly by The Federal Reserve. The U.S. economy has never before been under the command and control of a single entity – until now.

Some will scoff at the notion at first, however, all the proof that is needed is to look honestly at what out capital markets have morphed into over the last 7 years. The once great symbolic face and engine of capitalism, as well as its economic might and capital creation has been reduced to nothing more than an interface for a handful of wiz-kids with no business or economic prowess; just a Ph.D or specialized knowledge in mathematics or algorithms as to program High Frequency trading programs to skim or front-run provide liquidity for the “free money” pumped into the capital markets via the myriad of QE programs facilitated, and only made possible by the Federal Reserve. That’s not capitalism – that’s interventionism which fuels crony capitalism – pure and simple.

What remains currently since the true business and economic principles of supply and demand were pushed aside, then out entirely as we have understood them for over 200 years is what you have today is : A casino housing well-connected players. Nothing more – nothing less.

Remember not all that long ago where if it were learned, or was rumored, one approached the Fed’s “window” the implications as well as concerns it raised? Now? That window is seen in no different a light than the one located at any casino worldwide. Where one picks up their “chips” to play their index game of choice. Again, think about that for a moment and try to differentiate the difference between the two. Unimaginable just a few years ago. Today? It’s not only imaginable – its reality!

This issue has created a scenario that’s befuddled the so-called “smart crowd” yet is glaringly obvious to anyone with a moniker of business acumen.

The academics argue in some form of circular logic chain for not only the initial intervention, rather, as for its continuation in near perpetuity wrapped in a “chicken or the egg” type quandary or construct. i.e., “Without aggregate demand the rule is for intervention as to foster that demand.” The problem? The intervention is stifling, if not out right killing, any self-generating aggregate demand.

There’s no reason to start a new company or expand one when your competition is not only able to remain or compete when by-right they should have closed long ago, but have gained even more favorable attention within the capital markets via funding stock buybacks and dividends as their business model disintegrates. Situations like this are only made possible with a Fed’s more than accommodating stance in access to near “free money.” Period.

Why invest in the prospects of possible innovation when the sure thing of higher compensation to board members or CEO’s is there for the taking via the low hanging fruit of financial engineering the company into oblivion? Get rewarded today for “right sizing” or “downsizing” or whatever it’s called today to cover the ugly truth of firing as many as possible while keeping the doors open in some business that should have gone out of business entirely long ago. This doesn’t “save jobs” it destroys them. It’s out of that creative destruction that new or better companies emerge that hire.

Is there pain at times? Of course there is. However, as I’ve said many times “”Trying to alleviate that pain via unsound business practices will only increase the severity of that pain which can not be eliminated down the road.”

Remember, what you don’t (or won’t) do in this environment is what you’ve known as fundamental businesses practices when the name of the game is “dance till the music stops.” Regardless whether the company’s shoes have holes or worse.

Unwanted or irrelevant businesses remain alive to compete with young startups hindering true market forces to allow innovation and better products to come to market as the upstarts need to waste valuable resources competing against behemoths that would have collapsed under their own weight if not for their access to the “free money” still sloshing around.

If the upstart doesn’t have access? They’re at a competitive disadvantage near impossible to overcome. For if the bloated dinosaur has access to the money and the upstart doesn’t? Time attrition sounds the death knell of the upstart. While on the other hand: the genuine stalwart of a business that finds itself at the mercy of competition spawned by the throwing of that “free money” as to see what sticks by the “hot money crowd.”

Here there’s the opposite dynamic taking place with their ability to obscure true price discovery as they offers cut throat, or loss leading deals into that market made possible only through its available supply of that “free money” in what is now known as – a burn rate. Companies that would (or should) never have seen the light of a fund-raising door previously for out-rite comical business models have been greeted with open arms in a numbers game of “hope and pray” attitude of investing prowess. The job creation these types add have the staying power that make a may-fly feel like Methuselah.

Again: Why would any company invest its precious capital to take chances that may turn into tomorrows winners when the sure thing of spending those dollars till broke results in “winning” today?

And what about tax reform or business laws that may be hindering new or existing businesses making more and more non-competitive or the overburdening of antiquated fees, reporting requirements and far too many others to list here? No politician is going to seriously bang the table calling for reform to help incentivize growth when the Fed. can just supply advantages to today’s “winners” via its current steadfast stance to remain at the zero bound. Who needs competitive advantages when one has the advantage to access the Fed’s window or finance for nearly free? That’s a competitive advantage almost insurmountable, which in reality – is the best that money can buy.

Politicians and others talk about wage equality demanding hikes in the minimum wage, or a further enhancement to worker benefits and much, much more. And why shouldn’t they? Not only do they feel embolden they’re playing to a willing audience that sees itself as being “left behind.” Imagine that, a politician pandering to a group of potential voters preceding an election? Oh the humanity! Say it isn’t so!

The share prices of many of these companies have left previous highs far behind (as in when the financial crisis first hit) and now levitate at never before seen in the history of mankind highs. The argument is so easy to make to the economic or business unsophisticated as they try to square the circle of how their wages remain stagnant – and the CEO’s as well as Wall Streets grows, and grows, and grows.

Let’s not forget the glaring examples of what is not only seen as ironic, but to many, feels near criminal as they receive layoff notices only to read glowing reviews of how some of the banks that needed to be saved via taxpayer bailouts now tout their CEO’s as today’s newest entries into the “Billionaire Boys Club.”

They don’t understand the stock price is not rising for economic reasons (i.e., organic growth resulting in more net profits) but for nothing other than an over accommodating Fed. And no one wants them to know either. For if they did the next logical argument (or demand) will be: then where’s my bailout?! Or maybe they have. e.g, student loans and the call to just forgive them.

Add to this: What politician is going to call for government tax incentives for businesses to start, stay or come back to the U.S. when the selling of government debt is a non issue? After all; who needs fundamental economic policies when all that’s needed is for the  Fed. to buy more with a keystroke created with “money” created in the same manner? The stigma or absurdity of a central bank monetizing or purchasing its own debt is not only no longer taboo – it’s now accepted as prudent monetary policy!

Today the Fed. entices nearly all businesses to focus on short-term games of financial engineering rather than on core business principles to grow. This is what a stance at the zero bound gives rise to. Short term solutions such as stock buy backs, or the jettisoning of labor or anything not nailed down which will fuel higher share prices enriching both the C-level executives as well as fast money chasers, while potentially over financing their companies into debt Armageddon, leaving them vulnerable should things unexpectedly turn sour. This is all that matters in today’s business dynamic brought forth by current Fed. policies.

Then, just when there’s hope that a start toward normalization is on the horizon – they move the goal posts. Again.

First we thought more than 2 years ago as the Fed. signaled it had strong incentives to do so which led to the what is now called “the taper tantrum.” Then surely they thought early last year – but that came and went. Then it was looking like before the end of last year which started a rout so precarious it took Fed. official after Fed. official to hearken tones of “wait, wait, wait, we’re kidding, don’t be so quick to jump” saving the markets but conditioning businesses to once again “sit on their hands.” Because clarity just flew out the window – again.

Now here we are going into Q3 and GDP forecasts are abysmal, earnings season has been tepid at best, delusional via Non-GAAP at worse. Yet, companies are besieged with conflicting reports stating “as long as you don’t count using 1+1=2 then everything is great for 1+1 now equals ___________(fill in what ever number makes you feel good.)

Until the Fed. get’s out-of-the-way and allows businesses and markets to function the way they’re supposed to – you will not entice any business to start, or expand, hire, and more which is desperately needed. It just doesn’t work that way.

Aggregate demand is fostered by customers buying things they want or need via companies that will supply them with it as they compete with upstarts and older competitors for market share creating a self actualized as well as sustaining market. The longer the Fed. remains inserted within those markets forcing out the true fundamentals that support them, and tries to act as the supplier of first and last resort itself – the longer it will be that we’ll see an ever-increasing distortion resulting in fewer jobs, lower GDP, and more.

I’m not that well versed as to argue all the minutia of monetary policy as to what is the exact time to intervene, or reduce all or any intervention. That’s for others far more knowledgeable than I care to be. However, it doesn’t take a genius to understand once the initial panic of the financial crisis had subsided it was time for the Fed. to relinquish its interventionism and allow the markets to seek its proper levels. i.e., let the markets clear. Only then could the true rebuilding of the economy start in earnest. For what we have to today is nothing resembling an honest economy or recovery. It’s nothing but a house of cards susceptible to even the smallest of tremors.

Think I’m off base? Then tell me how an increase of 1/4 of 1% of the Fed’s fund rate is seen today by many resembling a blinding terror? It would also seem the Fed. is doing far too much hand wringing and other things in an effort to avoid criticism. What they might actually be coming to the realization of is: they have in fact done far more harm than good staying this low for so long. And now what they’re worried about is the reaction to such a move in policy. Even one as ever so slightly raising just 1/4 of 1% which could chain react into an out-and-out rout. I’m of the opinion this alone is paralyzing them in the fear that all the ensuing outpouring of criticism could turn overnight into pitchforks leaving the obvious as crystal clear as the statement I began with.

That’s no way to run an economy. Especially this one.