Pushing a String – Why the Fed Can’t Save the Day

Posted | 14/06/2019 / Views | 1644
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History is full of lessons we don’t seem to heed.  Consider the following excerpt from the US House Committee on Banking and Currency:

“Governor Eccles: ‘Under present circumstances, there is very little, if anything, that can be done.’

Congressman T. Alan Goldsborough: ‘You mean you cannot push a string.’

Governor Eccles: ‘That is a good way to put it, one cannot push a string. We are in the depths of a depression and…, beyond creating an easy money situation through reduction of discount rates and through the creation of excess reserves, there is very little, if anything that the reserve organization can do toward bringing about recovery.’

If those names aren’t immediately familiar it’s because that is from 1935 when Marriner Eccles was the Fed Chair dealing with the great depression.  One can easily see the same scenario playing out for current Fed Chair Jerome Powell in the not too distant future.

The Fed and other central banks around the world are trying to pull forward growth by offering stimulus in the way of low interest rates or quantitative easing.  Both of these measures increase debt.  As Michael Lebowitz penned in “Pulling Forward”:

“Debt allows a consumer (household, business, or government) to pull consumption forward or acquire something today for which they otherwise would have to wait. When the primary objective of fiscal and monetary policy becomes myopically focused on incentivizing consumers to borrow, spend, and pull consumption forward, there will eventually be a painful resolution of the imbalances that such policy creates. The front-loaded benefits of these tactics are radically outweighed by the long-term damage they ultimately cause.”

To wit, Lance Roberts of Real Investment Advice, expands:

“Unfortunately, the Fed is still misdiagnosing what ails the economy, and monetary policy is unlikely to change the outcome in the U.S., just as it failed in Japan. The reason is simple. You can’t cure a debt problem with more debt. Therefore, monetary interventions, and government spending, don’t create organic, sustainable, economic growth. Simply pulling forward future consumption through monetary policy continues to leave an ever growing void in the future that must be filled. Eventually, the void will be too great to fill.

Doug Kass made a salient point as well about the potential futility of Fed actions at the wrong end of an economic cycle.

“Pushing on a string is a metaphor for the limits of monetary policy and the impotence of central banks.

Monetary policy sometimes only works in one direction because businesses and household cannot be forced to spend if they do not want to. Increasing the monetary base and banks’ reserves will not stimulate an economy if banks think it is too risky to lend and the private sector wants to save more because of economic uncertainty.

This cycle is much different than previous cycles as there are a host of anomalous conditions that will work against the likely rate cuts that lie ahead.

What has occurred in the last decade? 

  • $4 trillion of QE
  • $4 trillion of corporate debt piled up
  • $4 trillion of corporate buybacks
  • A Potemkin-like expansion in earnings per share as the share count drops to a two decade low. (h/t Rosie)
  • Meanwhile, capital spending has failed to revive (leading to negative productivity growth).

While this is not a short term call for an imminent drop in the equity market, if my concerns are prescient and fully realized we will likely see more than the process of a market making a broad and important top.

The Fed is pushing on a string.”

Monetary policy is a blunt weapon best used coming out of recession, not going into one.”

The Fed, ECB, BoJ, PBOC, and even our RBA all are starting (before the recession) at ultra low rates and the ECB and BoJ even still in full QE mode.  They have done all their pulling to little effect and now have nowhere to go but try and push.  Grab a piece of string and see how that works out for you…