Some people know when to get into an investment before the masses and the true masters know when to get out before the panic. Sam Zell, the famed real estate investor is one such person. But what about those on the Federal Reserve Board. Brendon Brown, a scholar at the Mises Institute, asks an interesting question. Is Stanley Fischer, Member of the Federal Reserve Board leaving the Fed at the top of the Market? He posits that Fischer’s early departure from the Fed is driven by the fact that he knows the economy and credit cycle is in the process of rolling over. Here is what Brendon Brow has to say.
” Fed vice-chair Stanley Fischer’s surprise announcement of early retirement triggers the obvious question as to whether this could be the forerunner to a serious market and economic deterioration ahead. Monetary bureaucrats, even if signally bad at counter-cyclical fine-tuning, sometimes have a reputation for intuition about how to time their own career moves ahead of a crisis. In this case, such suspicion may be wide of the mark given the personal circumstances. Even so, the exit of a Fed Vice-Chair, who in many respects has been the pioneer and the dean of the prevailing doctrine in the global central bankers club, is pause for thought.
The Early Years
When Professor Fischer published his famous paper “On Activist Monetary Policy with Rational Expectations” (NBER working paper no. 341, April 1979), the fiat money world was well into the third stage of disorder following the collapse of the international gold standard in 1914. But things were at a temporary resting point where the skies seemed to be getting clearer. After the violent terminal storms of the gold exchange standard (in the early 20s to early 30s), and then of the Bretton Woods System, it seemed to many that the “monetarist revolutionaries” had found a better practical monetary navigation route. The Bundesbank, the Federal Reserve, the Swiss National Bank, and even the Bank of Japan were pursuing an ersatz gold rule of low percentage increases in the monetary base or a related aggregate.
Fischer vs. the Monetarists
Despite the optimism at large, Fischer issued a challenge. The monetarist rules (x percent growth of the chosen monetary aggregate) were doomed to fail when the underlying demand for money and monetary base, in particular, was so unstable.
Fischer rejected the new popular view (in the late 1970s) of the fashionable “classical economists” (for example Robert Barro) who argued that under market rationality monetary policy was powerless to influence the real economy. All the various trade-offs hypothesized by the Keynesian economists of the previous decade and pursued in part had been based on a view that central bankers could take the public by surprise (who would not realize what they were “up to” until later on). But once the public knew all Keynesian manipulations could not be effective.
In contrast, Fischer purported to demonstrate that if wages were rigid (most likely due to the existence of long-term contracts), then even given rational expectations, monetary policy could stimulate the real economy.
And so Professor Fischer, on the basis of his pioneering neo-Keynesian creed, preached that, yes, central bankers could and should pursue activist contra-cyclical strategies, especially when shocks were large and obvious. But yes, he also recognized that fine-tuning had its dangers and could morph into a long-run rising inflation rate, and so he recommended that policy be bound by the setting of a low inflation target. These ideas were in turn taken up and worked on by leading disciples (students) of Stanley Fischer, including Ben Bernanke and Mario Draghi.
The Birth of the 2% Inflation Standard
And so the fourth stage of fiat money disorder was born — what we may describe as the “global 2% inflation standard”. The prior monetarist experiments faded away in the decade following publication of Fischer’s paper (Paul Volcker abandoned monetarism by 1982, and the Bundesbank was the last hold-out in the year before the launch of the euro). At a stretch we could call this fourth stage the “Fischerian age of monetary policy”. Even though its author is now retiring, the outlook is for this stage to move eventually into a much more vicious sub-stage in which inflation rises far above the levels which the central bankers are purporting to target and the forces of rationality greeted by the classical revivalists have been completely trumped by powerful irrational forces which typify asset price inflation..
And all of this does not depend on who exactly President Trump decides to nominate in Fischer’s and Yellen’s place in coming months, even though there are reasons to speculate that the choice is likely to be pro-3% growth with the near-term target of avoiding defeat in next year’s mid-term elections. The bigger issue is that the so-called 2% inflation target belongs to a collection of fables under the title of the Emperor’s New Clothes. In today’s monetary environment where monetary base has been totally dislocated from the pivot of the monetary system (e.g., there’s no stable demand, distinctive qualities of base money are virtually eradicated, and both supply and demand are boated by QE) there is no basis – other than expectation inertia – to view prices of goods and services as anchored.
At the best of times no one knew the precise relationship between monetary aggregates and prices — and indeed under the gold standard or monetarism no one pretended to have the price path under control; at best money was under control and that should foster some long-run tendency for prices to return to the mean, but there was no assurance of this. Strikingly the “Fischerians” have lost all sight of the natural rhythm of prices as responding to fluctuations in the pace of globalization, productivity growth, and of course the business cycle.
There is every reason to believe that expectation inertia will snap at some point in the future. And the root combination of monetary disorder — a Federal budget deficit of 4-5-6% of GDP at a cyclical peak, a Federal Reserve determined to hold down rates and manage the government bond markets, an administration favoring a weak dollar — there are grounds for fearing a lurch of the monetary train towards high inflation, albeit possibly beyond the next business cycle trough. And all of that despite the pride of Stanley Fischer in his resignation letter to President Trump:
During my time on the Board, the economy has continued to strengthen, providing millions of additional jobs for working Americans. Informed by the lessons of the recent financial ciris, we have buildt upon earlier steps to make the financial system stronger and more resilient and better able to provide the credit so vital to the prosperity of our country’s households and businesses.
Power corrupts, and Washington corrupts absolutely. How can anyone pretend to have learnt the lessons and achieved the results until at least one long business cycle under the given monetary regime has been completed? Only then can all the mal-investment be counted and the financial quake or hurricane damage assessed.”
To see the original article, click here.
We can only speculate about what Mr. Fischer sees down the road. In addition to the monetary conditions discussed above, we all know that the financial condition of governments around the globe is horrendous. Here at home, the Federal Government has on balance sheet debt of $20 trillion and another $180 trillion of off-balance sheet excess liabilities (liabilities in excess of the taxes dedicated to paying those liabilities). State governments are in just as bad a shape. The states cannot balance their budgets, and their pension plans are bankrupt thanks to the zero interest rate policy pursued by the Fed & ECB, Bank of Japan, etc. and the refusal of State Government’s to fund those pension plans. It is very easy for Governors and Legislators to promise generous pensions to state employees so that those state employees for them. When the ticket comes due, they will be long gone and the state employee and the taxpayers will take it on the chin. The following chart provided by Bloomberg LLC shows the funding ratio of state pension plans by state. Not a pretty picture.
It is just a matter of time before the State of Illinois files for bankruptcy. Not only is their pension plan 64% underfunded, their state has not had a budget in years and they overspend so much that venders often wait for more than a year to get paid. There are other reasons things may get ugly in the years ahead. The growth in consumer debt, particularly student loan debt and subprime auto loans, means the system is just as leveraged as it was before the financial crisis. Seems people and the government never learn or they have learned that if they have a big enough problem, they might get bailed out.
This leaves us to wonder. Is the rally in the equity markets currently underway the blow-off rally that market a top for years to come? We are not sure, but trend following techniques should tell us if and when that day comes.
Just a little something to think about over the weekend.
