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Is the Fed in Control? If So, Control of What?

Reader Richard is wondering about a statement I made in Problem is Demand: First IBM, then Intel, now Google.

Specifically Richard questions my statement "In spite of what everyone seems to think, the Fed is not really in control of much of anything".

Richard writes ...

Hi, Mish

I am a big fan of yours but I am shocked, however, by your quote in my subject line. How can you say that when the Fed totally controls everything in the financial markets not only in the U.S. but much of elsewhere in the world? It is single-highhandedly propping up the U.S. equity market, rendering bond vigilantes ineffective in the bond market, and creating an "echo real estate bubble" at will!

Hoping to hear an elaboration from you in your next blog.

Regards, Richard

No Echo Bubble in Housing

Hello Richard, for starters, there is no echo real estate bubble.

Home sales are at depressed levels, financial institutions are still overloaded with hugely underwater properties, and prices have bounced a bit in some areas, by 5-10% bounces following 50-60% declines hardly constitutes an echo bubble.

Had Richard said the Fed created an echo bubble in stock prices, I would have agreed. Let's step back a second and look at the three primary things the Fed wants to accomplish.

Three Things Fed Desperate to Accomplish

  1. Stimulate Credit
  2. Stimulate Jobs
  3. Stimulate Housing

The Fed has failed at all three. Arguably, credit has risen, but nearly all of the rise is student loans, making debt slaves out of kids in the process, something the Fed certainly does not want to accomplish.

In September 2011, Ben Bernanke said he was surprised by weak consumer spending. I wrote about it in Bernanke, a Complete Dunce, "Puzzled by Weak Consumer Spending"

In March of 2012, Bernanke said he was puzzled over jobs. I wrote about that in Bernanke Puzzled Over Jobs, Cites Okun's Law; Six Things Bernanke is Clueless About

On October 15, the president of the New York Fed complained about the "poor performance of the U.S. economy" as well as "inadequate aggregate demand". For discussion, please see Recovery, Monetary Policy, and Demographics: NY Fed vs. Mish Analysis

How Can The Fed Be In Control When ...

How can the Fed be in control when it cannot spur jobs, it cannot spur housing, it cannot spur credit, it remains puzzled over numerous things, and in fact launched QE III in a moment of Panic!

To be sure the Fed has taken credit for the surging stock market.

However, in terms of the Fed's real goals, this is like attempting to cure lung cancer and failing, but by happenstance removing a wart from a big toe and declaring success.

The Fed is not in control, it is only an illusion. One other person commented on this recently.

Please consider the Hoisington Third Quarter 2012 Review by Lacy Hunt. The article discusses QE1, QE2, QE3, demand curves, commodities, and numerous other ideas in a six-page PDF. The article is well worth a read in entirety, but here are a few key snips ...

While prices for risk assets have improved, governments have not been able to address underlying debt imbalances. Thus, nothing suggests that these latest actions do anything to change the extreme over-indebtedness of major global economies.

To avoid recession in the U.S., the Federal Reserve embarked on open-ended quantitative easing (QE3). Importantly, the enactment of QE3 is a tacit admission by the Fed that earlier efforts failed, but this action will also fail to bring about stronger economic growth.

Three studies show that the impact of wealth on spending is miniscule -- indeed, "nearly not observable." How the Fed expects the U.S. to gain any economic traction from higher stock prices when rising commodity prices are curtailing real income and spending is puzzling. This is particularly relevant when econometricians have estimated that for every dollar of gained real income, consumption will rise by about 70 cents.

Conversely, the Fed actions are causing real incomes to decline, which has a 70-cent negative impact on spending for every dollar loss. Compare that with the 0.004 positive impact on spending for every one-dollar increase in wealth. Former Fed Chairman, Paul Volcker, summarized the new Fed initiative as sufficiently and succinctly as anyone when he stated that another round of QE3 "is understandable, but it will fail to fix the problem."

Fed Without Options

Lacy Hunt concludes with ...

For Fed policy to improve real GDP, actions must be taken that either (1) shift the entire demand curve outward (to the right), or (2) do not cause an inward shift of the AS curve that induces an adverse movement along the AD curve. Accordingly, the Fed is without options to improve the pace of economic activity.

Bernanke says he is not out of options, so Lord only knows what he may try. However, Lacy Hunt's statements are accurate.

Simply put, the Fed is without options that will do any good for the economy.

Control of Stock Market? Interest Rates? What?

The Fed is not in "control" of the stock market. Creating echo bubbles does not constitute control. Bubbles, by definition, pop.

If you think the Fed is in "control" of interest rates, you need to reconsider that as well. Certainly the Fed has distorted the bond market and yields, but most likely in the direction of the trend. Regardless, distortions do not constitute "control" no matter how it appears in short-term periods.

Given the folks at Hoisington and other small select groups of individuals and bloggers know as I do, that Fed "control" is nothing more than a mirage, I need to make a slight change in my statement.

Here is the revision: In spite of what [nearly] everyone seems to think, the Fed is not really in control of much of anything.


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