Clive Hale

Clive has been involved with the investment industry for over 40 years as a fund manager, funds researcher, non-exec director, investment co

Feb 18, 2017
2 min read
Fed Up – February 18th 2017

If you were going to set up an organisation to help control and regulate the economy and the banking system how would you start? Would you employ over 1,000 Ivy League trained economists, many with PhDs, but little or no practical knowledge of running businesses? Would your board of governors come from the same background and would the owners of the organisation be the very bankers that you were duty bound to regulate? I somehow doubt it. But even if you were so minded would you then allow untested economic theories to be implemented without a thorough study of the potential consequences of zero or even negative interest rates on the real economy or the massive inflation of your balance sheet by the purchase of trillions of dollars’ worth of government debt? No, you wouldn’t, but welcome to the world that is the Federal Reserve System of the United States.

Nine years into the recovery from the Great Financial Crisis and the Fed is still wondering why its policies are not working as intended. Their theory goes that if you lower interest rates, companies will be happy to borrow and invest in their businesses as consumers, who begin to feel the wealth effect of rising property and stock prices, pick up their spending levels. Several problems there. Most consumers don’t benefit from “trickle down wealth” and corporations, faced with less than robust demand, saw a perfect opportunity to massage earnings per share by increasing debt to buy back their own shares, which does very little for the economy, but does boost the bonuses paid to corporate executives.

On the regulatory front the legislation brought in after the GFC, known colloquially as “Dodd Frank”, to control the excesses that led to the crisis in the first place, is under threat. It was probably not the best thought through piece of legislation and was of such size that it is unlikely that many senators or members of congress, who passed the bill, have read the thing. It did of course constrain the investment banking community from running proprietary operations amongst other things, which in the run up to debacle were among their most profitable pastimes.

Not surprisingly, given that the Fed is owned by the banks, their protestations and not inconsiderable financial lobbying have found the ears of the Chairwoman, who recently opined that the regulations need relaxing again. Added to the view that interest rates are now a one-way bet, it is no surprise that financial stocks, and the fortunes of the investment banking sector in particular, have been on the rise. The question that doesn’t seem to have been asked is what happens to all those interest rate derivatives when rates get a serious move on.

The 10 year US Treasury note reached a high in terms of yield in 1981 of 15.84%; younger readers may need to go and have a lie down. This was from a low 35 years earlier in 1946 of 2.08%. 35 years on from the peak, in 2016, Treasuries hit a low of 1.36%. The perceived wisdom is that rates won’t get above 3% as this will put a cap on economic growth and rates will start to fall again. At the same time, US equity prices are reaching for the sky. However, seven year projected real returns for US large cap stocks, from US based investment managers GMO, are around minus 1%-2%, which implies something of a re-rating from here. GMO’s CIO is Jeremy Grantham, a Yorkshire man at heart, who knows a good deal when he sees one, and whose favourite observation is that value managers are never wrong, just early. If you are wondering how sustainable the Wall Street fan club at Dow 20,000 can be, just remember which organisation has been mainly responsible for getting us to these giddy heights via a series of uncontrolled and untested policy experiments; aka cheap and “free” money.

Clive Hale –The View from the Bridge – February 18th 2017

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PS – the title for this piece and some of its content has been inspired by Danielle DiMartino Booth’s new book Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America. She was adviser to Richard Fisher the former president of the Dallas Federal Reserve bank, which gave her great insight into the workings of the machine. I have quoted below the publisher’s introduction to the book.

In the early 2000s, as a Wall Street escapee writing a financial column for the Dallas Morning News. Booth attracted attention for her bold criticism of the Fed’s low interest rate policies and her cautionary warnings about the bubbly housing market. Nobody was more surprised than she when the folks at the Dallas Federal Reserve invited her aboard. Figuring she could have more of an impact on Fed policies from the inside, she accepted the call to duty and rose to be one of Dallas Fed president Richard Fisher’s closest advisers.

To her dismay, the culture at the Fed–and its leadership–were not just ignorant of the brewing financial crisis, but indifferent to its very possibility. They interpreted their job of keeping the economy going to mean keeping Wall Street afloat at the expense of the American taxpayer. But bad Fed policy created unaffordable housing, skewed incentives, rampant corporate financial engineering, stagnant wages, an exodus from the labour force, and skyrocketing student debt. Booth observed first-hand how the Fed abdicated its responsibility to the American people both before and after the financial crisis and how nobody within the Fed seems to have learned or changed from the experience.

Today, the Federal Reserve is still controlled by 1,000 PhD economists and run by an unelected West Coast radical with no direct business experience. The Fed continues to enable Congress to grow our nation’s ballooning debt and avoid making hard choices, despite the high psychological and monetary costs. And our addiction to the “heroin” of low interest rates is pushing our economy towards yet another collapse.

This book is Booth’s clarion call for a change in the way America’s most powerful financial institution is run–before it’s too late.