Market watcher: Economic ‘distortions’ are the Fed’s fault

When it comes to investors, bankers, and politicians, incentives matter. Not many writers know that better than Jim Grant, a veteran commentator who has worked in financial news for more than 50 years, previously at said Barron but for himself since 1983, as the author of the weekly newsletter Grant’s Interest Rate Observer. The bespectacled and bow-tied Grant’s columns and many books criticized the Federal Reserve’s money printing and highlighted the flawed assumptions of a character he called “Mr. Market.” A good time collection is 2008 Mr. Market Miscalculation: The Bubble Years and Beyondthat the Financial Times approved time reviewed, with John Authers celebrating the many “stunning examples of presence” as well as Grant’s “howling sense of humor.” This weekend, Grant argued that the Federal Reserve has ignored incentives for nearly a decade, and the economy is paying the price for another miscalculation.

“The Fed is the No. 1 problem in American finance,” he said SPOKE MarketWatch on Sunday, arguing that the central bank has harmed markets and the economy for decades in ways that were “unintended but not entirely unpredictable.”

Grant predicted many mistakes in his decades of watching the markets. In 2004, for example, he warned that something was going wrong at Washington Mutual—about four years before the bank’s collapse in September 2008. The number of risky loans on which the interest rate could be adjusted and the principal payments deferred, called “Option-ARMs,” jumped from 5% to 40% of the bank, he said, putting average Americans at risk of losing their homes if the Fed raises the rates.

“When the Fed raised the funds rate in 1994, it captured hedge funds and interest rate speculators. When it raises the funds rate next time, it captured Mr. and Mrs. America,” he wrote Grant in his 2004 column.

For decades, Grant has warned that rapid increases in interest rates after periods of historically low rates tend to catch investors and CEOs off guard, leading to serious illness. in the economy—and he sees the same pattern happening again today.

Over the past 14 months, he says, Fed officials have raised interest rates at an unprecedented pace to combat inflation, which hit a peak of 9.1% in June. Amid improvements in supply chains and easing commodity prices, they managed to slow annual consumer price inflation to 4.9% last month, but that was well below their 2% target. target, which means more rate hikes are possible.

Higher rates are a big departure from what most investors and bankers are used to. In the years following the Global Financial Crisis, and throughout the pandemic, the Fed kept interest rates close to zero in an attempt to stimulate lending and investment in the economy. Grant argues that it is called free money period encouraged investors and bankers to chase risky assets, as typically safe havens such as Treasuries, savings accounts, and investment-grade bonds did not generate significant returns.

“I think for the most part that suppressing rates is indicative of all sorts of distortions in the economy,” he explained. “It causes people to go and reach for growth, for results as if they were on their hands and knees with a flashlight looking under their furniture. for some return on their savings.”

The risk assets that investors are fighting for during 2020 and 2021 have not fared well in the past year amid rate hikes, with tech stocks falling nearly 30% and cryptocurrencies shedding $2 trillion market cap (or two-thirds of their previous value).

Grant’s warnings echoed those of another prominent financial commentator and author, Edward Chancellor, who called inflation “hangover” from the insolvency of the central bank in early 2022. Later that year, Chancellor released The Price of Timea history of interest rates, which argues that central banks have distorted the “natural rate of interest” repeatedly for hundreds of years—with disastrous effects.

The cry of a goldbug

Grant believes years of low rates have also led bank executives to look for more yield, pushing them to invest in long-dated bonds that offer slightly higher returns but they are exposed to problems when interest rates rise. He noted that many of the latest issues in the banking industry, including breakdown on Silicon Valley Bank and First Republic Bank, related to this issue. Simply put, bankers bought assets that didn’t pay enough to cover their rising deposit costs, and when investors noticed, it led to a bank run.

And Grant worries that the Fed’s balance sheet has similar problems as it embarked on a somewhat controversial policy called quantitative easing (QE) after the Global Financial Crisis in an attempt to spur economic growth. The central bank buys government bonds and mortgage-backed securities on the open market in hopes of increasing lending and investment in the economy and keeping interest rates low.

Grant’s years of criticism of easy monetary policy won him fans on the more conservative side of the political spectrum—or fans of classical economics. For example, former Rep. Ron Paul, who became an unlikely dark horse presidential candidate in the 2012 Republican primary with his campaign to “audit the Fed,” cited Grant as his choice to replace Fed Chair Ben Bernanke. More recently, Grant won positive reviews from the economics establishment for his biography of Walter Bagehot, the banker and former editor of The Economist who ironically influenced much of Bernanke’s financial firefighting during the Great Recession that followed the crash. in 2008. On Sunday, Grant criticized Bernanke again.

“This idea that the Bernanke Fed came up in 2010-11, I think it’s a very bad proposition for a long time. I don’t think it’s going to work,” he said, referring to former Fed chair Ben Bernanke and QE.” The Fed, of course, is not First Republic Bankbut its balance sheet is similar to First Republic and Silicon Valley Bank, as it earns 2% of its assets and pays 4-5% of its liabilities.”

Extended periods of near-zero interest rates may also stimulate increased government spending, as low rates prevent interest payments on the national debt. But now, the rates are increasing, and the legislators hit on $31.4 trillion The debt ceiling at a time of growing political divisiveness, there is growing concern that the US may not be able to pay its bills—which Grant sees as at least partly a result of the Fed’s policies.

So, for Grant: “The last 10 or 12 years in terms of Fed policy and general interest rate suppression” laid the groundwork for the most recent problems in the regional bank and “game in debt.”

For investors, Grant says this means gold—the world’s oldest safe haven—is the only thing worth owning. Like his friend and supporter Ron Paul, Grant has long been known in the financial world as a “gold bug,” who thinks President Richard Nixon’s decision in 1971 to abandon the gold standard was a mistake, which opens the door to a Fed run amok. And even now, with the Fed raising rates, he fears inflation will continue to be an issue, making gold an expensive asset. Like a fire in a coal mine, we may not always see inflation, but it is always burning, he said.

“I’m somewhat of a broken record on gold,” Grant told Schiff Gold in July interviews. “I’m going to continue this broken record and see that people still don’t understand the fundamental inherent weaknesses of the financial system that has been in place since 1971.”

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