FOMC Statement – September 17, 2014

The FOMC released its latest policy statement on September 17, 2014.  The Fed will continue its “taper” by reducing its purchases to “just” $15 billion per month.

For reference, in most of 2013, the Fed was purchasing assets (creating money) by the tune of $85 billion per month, which is an annual rate of about $1 trillion.  So $15 billion per month, which would have been considered a lot 6 years ago, is a huge reduction compared to what the Fed had been doing last year.

If nothing drastic happens over the next 6 weeks, then the Fed is expected to end its so-called quantitative easing program at the end of October.

If you study Austrian school economics, and in in particular the Austrian Business Cycle Theory, you will know that loose money and artificially low interest rates cause resources to be misallocated and unsustainable bubble activity.  At some point, this has to stop.  Just by reducing the rate of monetary inflation, this can be enough to pop the bubble activity.  But we have to realize that there is a time lag.

In other words, if the Fed doesn’t ramp up the digital printing presses again, then we are going to see a recession in the somewhat near term.  The only exception to this might be if there is some kind of a major event or if commercial banks start lending out some of their excess reserves.

Price inflation, according to the government’s CPI numbers, had started to pick up a few months ago.  But the report for August showed it has slowed down again.  If the CPI stays down, this is a sign that Americans are holding back their spending and borrowing.  It is also a sign that a recession may not be far away.

Everyone is obsessed with interest rates right now, but I’m not sure why.  The Fed controls the federal funds rate, which is the overnight borrowing rate for banks.  This rate has mattered in the past because the Fed typically would increase it by tightening monetary policy and it would decrease the rate by loosening monetary policy.  But this rate has been near zero for almost 6 years.  It hasn’t mattered what the Fed has done in terms of monetary policy.

The Fed is not going to raise the federal funds rate by massively selling off assets.  That would crash the economy quickly.  Its main option is to pay a higher interest rate on excess reserves.  But in terms of creating money out of thin air, it doesn’t seem to matter what the Fed does in relation to the federal funds rate.

So why is everyone concerned about the interest rate?  We were concerned about this in the past because it determined the monetary policy.  But we already know what the monetary policy is.  The Fed is now purchasing assets at $15 billion per month and it is expected to stop at the end of October.  It continues to roll over its maturing debt, making sure the monetary base does not go down.

There are a lot of factors at play right now, but I am leaning towards a recession.  I would not be in the stock market except as it relates to a permanent portfolio and in terms of specific stocks and sectors.  The stock markets may hit new all-time highs for a little while longer, but I would rather be out a little early than out too late.

4 thoughts on “FOMC Statement – September 17, 2014”

  1. I’m getting the feeling that now might be a reasonable time to adjust my savings and investments to protect them from the ravages of a recession of possible inflation. But how best can I achieve this with investments like an IRA, 401k and 403b where my investment options are limited. The IRA is pretty versatile, but the others not so much. Should I consider holding less in cash?

  2. If anything, you might want to increase your cash right now. I see a recession first, then higher inflation.

    Check to see if you can invest in PRPFX. It is a mutual fund that somewhat mimics the permanent portfolio.

  3. I do own PRPFX, and it has performed terribly. In fact yesterday it dropped nearly 8%!

    What’s your take on investing in treasuries as a way to ride out a recession — like VIPSX? Or just putting savings into money markets? I’m struggling to come up with a plan to preserve my savings during what I feel might be a coming recession.

  4. I don’t think PRPFX dropped 8% in one day. It is possible it paid out dividends.

    PRPFX is still my favorite mutual fund, despite having 10% in Swiss francs, which I think are terrible now.

    I would keep the 25% in bonds and 25% in cash/ liquid funds. If we hit a recession, that should keep your others from bringing you down.

    You don’t wan to be too heavy in treasuries because there is still a risk of higher rates. In the 1970s, there were higher rates with recession. We aren’t there yet, but it could happen again.

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