The Fed Still Holds Up Asset Prices, Despite Rate Hikes

The Federal Open Market Committee (FOMC) released its latest statement on monetary policy on December 13, 2017.  As expected, the target federal funds rate was hiked by a quarter percent.  The federal funds rate target is now in the range of 1.25% to 1.50%.

This was widely expected, and therefore, the markets did not react negatively.  Stocks were largely flat or up, and gold was up for the day.  The rate hike was already priced in.

When we talk of rate hikes now, it has almost nothing to do with the money supply.  While the Fed is continuing its program of rolling off assets at around $10 billion per month (a very small percentage of the monetary base), this is not directly correlated with the hike in the federal funds rate.  (The roll off rate will increase to $20 billion starting in January.)  Since the commercial banks still have huge amounts of excess reserves, the Fed increases the interest rate it pays to banks on their reserves in order to hike its target rate.

On the same day as the Fed’s statement, the latest CPI numbers were also released.  The CPI was up 0.4% in November, but the CPI less food and energy was only up 0.1%.  The more stable median CPI was up 0.2% and stands at 2.3% year-over-year.  Price inflation may not be as tame as what the Fed makes it out to be, but it isn’t roaring out of control either.

The place where we continue to see high price inflation is in assets.  These prices are largely ignored in the government’s statistics in calculating consumer price inflation.  The problem is that consumers do buy houses, stocks, fine art, and even Bitcoin.  While these are considered assets, they still have prices, and people spend money on these things.

For those who follow Austrian school economics (free market economics), it may be curious why asset prices continue to rise.  The Fed is hiking rates and deflating its balance sheet (albeit slowly).  The Fed stopped QE3 over 3 years ago now, yet the bubbles have yet to pop.

First, it does take time for things to play out.  Just as an inflation in the money supply does not hit instantly, a deflation also doesn’t hit instantly.  It takes time for the previous malinvestment to be exposed.

Even more importantly, I believe that this bubble is taking longer because of the financial crisis nearly a decade ago.  More accurately, I believe it was the Fed’s response to the financial crisis that is holding up this market.  And it is possible that it could make it last longer than what seems possible.

The Fed’s reaction to the crisis in 2008/ 2009 was unprecedented.  It was probably even a surprise to those who advocate massive intervention in the marketplace.  The Fed bailed out major banks and financial institutions, and it nearly quintupled the adjusted monetary base.  This would not have been believable if you had predicted this in 2007.

The Fed acted so aggressively that there is even more of an implicit guarantee than there was before.  At this point, it is even hard to use the word “implicit”.  It is almost a certainty that the Fed would act aggressively again if the bottom fell out.  In other words, the moral hazard has increased.

Stock investors and real estate investors know that if things turn ugly, the Fed will quickly step in and try to revive things.  If the Fed quintupled its balance sheet before, why can’t it do it again?  As long as the Fed is willing to step in with an aggressive easing (i.e. digital money printing), then there is a lot less to fear.

The same goes for bond investors, or even more so.  It is possible that stocks could fall despite more money creation from the Fed, particularly in the short run.  But for bond investors, they know that the Fed will create money by buying assets.  And when those assets are bonds, then there really isn’t much to fear as long as price inflation remains relatively tame.

The Fed isn’t holding down market interest rates and propping up asset prices by its actions.  It is doing these things because of its previous actions and the anticipation that it would do so again.

For that reason, it makes it difficult to short the market right now.  The boom and bubbles are unsustainable, and they will eventually turn to a bust.  But things could go on for a while longer because of the Fed’s willingness to step in right away.

The Fed will ultimately not be able to stop the implosion, but it does have the ability to kick the can down the road.  We just don’t know how much road it has left.

10 Reasons Not to Buy a House

There are arguments for and against homeownership.  For full disclosure, I am a homeowner.  I enjoy the benefits, and I also experience the hassles.

Homeownership is pushed in our society, particularly in the U.S.  It is pushed by public opinion, and it is also pushed through government in the form of many incentives and subsidies, particularly when it comes to handing out mortgages.  The push for homeownership has perhaps slowed a bit since the housing bust a decade ago, but it is still often touted as the smart thing to do.

Here are 10 reasons not to buy a house (or condo or townhouse).

  1. If you ever want to move or need to move, you will be thankful for not owning a house.  A house ties you down to one spot.  If you are offered another job, even if it is just on the other side of the city, it becomes a bigger roadblock if you own your house.
  2. Buying a house ties up liquid money.  Even with the subsidized mortgage market, most people have to put down at least 3%, plus closing costs, plus the costs of moving, plus furnishings, plus fixes, etc.  This can cause unnecessary stress if you don’t have backup reserves, especially for emergencies.
  3. If the toilet is broken, you are responsible for fixing it.  If you are renting, you can just call and wait for the maintenance guy.
  4. Home ownership not only takes your liquid money, but you should have money in reserve just to deal with the house for any unexpected repairs.  Actually, they shouldn’t be called “unexpected” because you are guaranteed to have repairs.  If you need a new air conditioning unit, expect to pay many thousands of dollars.  If you decide to buy a house, be sure to factor in all of the things that can go wrong.
  5. You also have things that will require somewhat regular maintenance such as your air conditioner and your garage door.
  6. If you aren’t in a condo or townhouse, then you are probably responsible for maintaining your lawn.  While some people like doing yard work, it is mostly a hassle.  It can also be an added expense.
  7. While this one does not have to be true, there is a tendency for it to be true.  When you own a house, you have a tendency to accumulate more stuff (i.e. junk).  It’s not to say that there aren’t many renters living with a lot of clutter, but there is something about owning a home that encourages the accumulation of even more stuff.
  8. If your monthly payments become a burden and you want to lower your expenses, it is difficult when owning a house, especially if you don’t want to sell it.  If you rent, it is easier to move.  You can just wait until the end of the lease and then find a cheaper place to live, even if it means finding something smaller.
  9. When you own a house, moving is very expensive.  Unless you are building a real estate empire and renting out your house when you move, then the process of moving is really expensive.  You really should never buy a place if you think you will not be living there for at least 7 years (at a minimum).  If you sell a house for just $100,000, you are looking at close to $10,000 in closing costs if you pay the standard 6% in real estate agent fees.  This does not include the actual cost of moving, nor does it include the holding costs if you move out before you sell.
  10. Homeownership is not an investment.  Some people get lucky in a booming market, and some are smart enough to sell near the top. But overall, buying a house is not an investment if you are planning to live there.  It is a consumer good.  It just so happens it is an important consumer good in that it provides shelter for you. But most people are not just buying a roof over their head.  Buying a house can be a good forced savings plan if you live there for a long time and don’t extend your loan.  But if your only goal is to make money, you are better off renting a really cheap place and investing the difference.

Again, there are many reasons to favor homeownership, but you should go into it with your eyes wide open.  You must consider your own situation and whether owning is right for you.

The Jerome Powell Bust

Jerome Powell will likely be the next chair of the Federal Reserve.  He will take over from Janet Yellen at the end of January 2018.  Whether Yellen knows it or not, her exit will be a blessing for her.  She should be quietly thanking Donald Trump.

Ben Bernanke took over as Fed chair in 2006.  He inherited a mess, but it wasn’t known at the time.  Even for those who knew there were underlying problems in the economy, most didn’t expect the drastic nature of the housing bust, financial meltdown, and overall recession.  There is absolutely nothing Bernanke could do to stop the bust from coming.  Perhaps he could have delayed it a little bit through monetary inflation, but it likely wouldn’t have postponed it for long.

Bernanke was a really bad Fed chair, but not because we had a severe recession and financial crisis.  He was a bad Fed chair because of his response to the financial crisis.  To the bankers and others who were bailed out, Bernanke was not a bad Fed chair.

He presided over the greatest monetary expansion in the history of the Federal Reserve.  He approximately quintupled the size of the adjusted monetary base.  But due to the piling up of excess reserves by banks, coupled with continued fear in the markets, consumer price inflation never really took off.  The same can’t be said for asset prices as reflected currently by the big valuation increases in housing and stocks.

While Yellen came into office as an Obama-appointed Keynesian, she has actually be relatively subdued.  She wrapped up QE3 in her first year and has not expanded the balance sheet since then.  While it took her a while, she actually just started the Fed’s program of reducing the balance sheet, even if slowly.

If we are to believe the Austrian Business Cycle Theory, the Fed’s loose monetary policy from 2008 to 2014 caused malinvestments (misallocated resources).  Therefore, resources are not all currently being used in an efficient manner in accordance with consumer demand.  At some point, these malinvestments will be exposed as such, and there will be a correction.  The Fed’s tight monetary policy will put further pressure on the situation.

Much like Bernanke, Jerome Powell is going to inherit a mess.  He will be stuck with the malinvestments that started under Bernanke.  Powell will likely oversee the bust phase.  Unfortunately, he is probably like Bernanke in other ways in that he will likely resort to significant monetary inflation when faced with a crisis.

When Donald Trump was campaigning for president, he mentioned a few times that there were bubbles in the economy.  As soon as he became president, he started taking credit for the boom.  This was stupid, but politicians just can’t help themselves.  Since Trump has been taking credit for the little boom, he will own the bust.

There will be many bubbles that pop.  Stock prices will take a huge hit.  Housing will take a hit in many areas.  Some fads like cryptocurrencies – particularly Bitcoin – will take a hit.  Some commodities will take a hit, although gold is less certain.

Assuming we don’t see a significant pickup in price inflation, government bonds will probably not go bust in the recession.  That bubble will get blown bigger in the short run.  Investors still see U.S. government debt as a safety vehicle.  They will seek to lock in long-term rates.  Therefore, expect interest rates to actually fall in the next recession.

The one bubble we need to pop more than anything is the bubble that is Washington DC.  We need a drastic reduction in the size and scope of the federal government.  Unfortunately, the only way we are likely to see this happen is to have much higher interest rates where the Fed can no longer intervene due to fears of rampant inflation.  As long as the Fed is allowed to step in as a buyer in the bond market, then the government bubble will probably keep going.

While the Fed has not been a net buyer of government debt for over three years now, it still stands there ready to act if needed.  This helps to support the bond market, even when the Fed is not actually buying.

Jerome Powell will be little different from previous Fed chairs.  But the situations may differ, especially in size.  The current system of Fed interference and massive deficits will come to an end eventually.  We know this because it isn’t sustainable over the long run.  When the next recession hits, the annual deficit will quickly balloon over a trillion dollars.  At some point, the debt will become unmanageable.

There is a tendency for us to let our guard down, partially due to the fact that we can’t constantly be on high alert.  When times are good, or at least decent, then we think they will just keep humming along.  But one day, something will happen and the dominoes will start to fall.  We don’t know when that will be, but we should at least not be surprised when the day comes.  Neither should Jerome Powell.

Sexual Misconduct vs. Killing Foreigners

For anyone living under a rock, there has been a huge wave of women coming out accusing many famous men of sexual misconduct, or worse in some cases.

The first major person to fall was Harvey Weinstein, or at least this seems to be the case that triggered the wave to follow.  Morning hosts Charlie Rose (CBS and PBS) and Matt Lauer (NBC) have both lost their jobs.  Senator Al Franken and Congressman John Conyers (among other politicians) have also been accused, but they have not resigned from Congress.  In Franken’s case, there is a picture that proves at least part of the accusations.

As a libertarian – and I’m sure the same goes for many conservatives – it has been a somewhat enjoyable spectacle.  The scandals have focused around Hollywood and Washington DC.  When I say Hollywood, I am really including New York and the entertainment industry in general.

It is the politicians and those in the entertainment industry who tend to be the greatest advocates of statism.  They are generally opposed to liberty, except in cases where it benefits them personally.

They are also a bunch of hypocrites.  These are some of the same people who were blasting Donald Trump for making lewd or rude comments about women.

Of course, these people were already hypocrites because they gave Bill Clinton – the rapist – a pass for decades.  They also gave a pass to his so-called wife who tried to smear the women who accused him.  Bill Clinton was charming enough that they could overlook his misdeeds.  If there is one really good thing about this whole thing, it is likely the end of the Clintons, at least in terms of political office.  With the uproar now, it gets much harder to defend Bill Clinton, even though the previous credible accusations against him have not changed.

To be sure, many of the women in politics and entertainment are just as hypocritical.  It would be hard to believe that none of these women knew what was happening behind the scenes.  And I’m not saying it would have been an easy decision for them to go public, as it probably would have ended their careers at that time.  Still, they had no problem sitting there with a straight face telling us about how we can’t elect the womanizer that is Donald Trump.

Despite the entertainment value of these people falling, it is also unsettling to a certain degree.  Most of the cases are not accusations of rape, and some are not even accusations of sexual assault.  Some of it is “misconduct”, which leaves open a big area for interpretation. If a man makes it known to a woman that he finds her attractive, does that become misconduct, even if it is done in a non-threatening way?

Harvey Weinstein is probably a criminal in that he used force or the threat of force against women.  In many of the cases, it is more a case of being immoral or being indecent.  Still, in a relative free market, there are consequences for these actions without having broken any laws.  If anyone wonders how a libertarian society can punish immorality, then here is a good example.

The unsettling thing about all of these cases is not knowing where it will end.  You start to get into a lot of gray areas that are not clear-cut.  It is also a problem that it could be setting us up for false allegations down the road.  My guess is that most of the allegations up to this point have been true, but even here I don’t really know.

It is not hard to think of a scenario where a few people get together and decide to make false accusations against someone who they detest for other reasons.  This is easy to envision with future political campaigns.  At some point, we are going to have to give the benefit of the doubt to those being accused, or at least apply a similar principle of innocent until proven guilty, even if there are multiple accusations.  Just because a couple of women say something about some celebrity doesn’t automatically make it true.

There is one other unsettling thing about this whole thing for me as a libertarian, which I alluded to in the title of this post.

There is this widespread outrage about men making inappropriate advances on women.  Meanwhile, innocent people overseas continue to die due to U.S. drone bombings, U.S. sanctions, and outright war.  There are victims in Iraq, Afghanistan, Libya, Syria, Yemen, other places in the Middle East, and many countries in Africa.

While Matt Lauer gets humiliated and is fired from his job, Barack Obama still walks around as a hero in the eyes of the establishment media.  It doesn’t matter that Obama helped starve people in Yemen, or that he caused massive death and destruction in Libya and Syria.

Maybe Harvey Weinstein will end up at trial. Maybe he will go to jail, as he probably should.  But meanwhile, George W. Bush, Dick Cheney, Colin Powell, and all of the other liars are walking free.  They can lie us into war and slaughter hundreds of thousands of people and destroy entire countries, yet they do not seem to be condemned in the same way that some of these celebrities are now.

Of course, this isn’t to defend the celebrities in any way.  It is an issue of proportionality though.  I wish society would have the same outrage at the killing of innocent foreigners as they do at men committing sexual misconduct.  Of course, there should be far more outrage at the killing of innocent foreigners, but at this point, I would be happy if it got the same attention.

This is the world we live in.  Still, there is an optimistic side to take.  You never know what is building up in society that will all of a sudden come loose.  Because of allegations against Weinstein, it caused a great wave of people to come forward out of the woodwork.

Maybe something similar will happen in foreign policy.  Maybe there will be a whistleblower that triggers a bunch more to come forward. Maybe some particular incident of foreigners being killed overseas will spark outrage about all of the killings.  Sometimes it just takes one thing to light a spark, and you never know where it might come from.

Let’s hope that one day we will see headlines plastered all over the place about the innocent people in the past who have died at the hands of the U.S. government with its interventionist foreign policy.  These are victims who can’t speak out, but there are others who can speak out for them.