Chris’ note: Today, the Federal Reserve cut interest rates for the first time in a decade. It’s a 180-degree turn for Fed chief Jerome Powell. As recently as December, he was promising at least two rate hikes in 2019.
Powell’s U-turn will come as no surprise to readers of Legacy Research cofounder Bill Bonner. He’s been saying for some time now that the Fed always commits the same three mistakes… and eventually, these mistakes will lead to financial disaster.
First, it keeps rates too low for too long. This pumps up the stock market bubble. Second, the Fed raises rates, causing a serious allergic reaction on Wall Street. Then it does what Powell did today… and commits Mistake No. 3. It medicates markets with more low rates so it can reinflate the bubble.
But as you’ll learn below… no amount of rate cutting can stave off a recession and a bear market forever.
The Fed still believes it can manage the economy.
It thinks it knows what interest rates should prevail… and what stocks should sell for… and where consumer prices should be.
But all the evidence and sensible theory is against it.
The likelihood a bunch of Ivy League PhDs will find exactly the prices that the economy needs is remote. The Soviets couldn’t do it. The Chinese couldn’t do it, either.
Nobel Prize winner Friedrich Hayek explained why no one can. No central authority has all the information it would need to plan an economy.
That’s the beauty of a free-market economy. It doesn’t require quack economists who claim to be able to do impossible things.
A planned economy will work properly only if the planners know what the hell they are doing.
A free-market economy can work well in total ignorance. Markets discover new prices every day. No one needs to know the answers in advance.
But the geniuses at the Fed deny it.
They claim they can do what no mortal has ever done – impose their judgment on the markets and make the economy better than it would have been without them.
For their part, investors don’t question it.
They still believe the Fed has their backs, as it has had since Fed chief Alan Greenspan slashed rates to stave off the 1987 crash. The buy-the-dip mentality still seems to be a great way to make money.
Until it isn’t, of course.
Which is what happens when the Fed changes course… or runs out of claptrap.
That is where we were up until late last year.
The brains at the Fed believed they had done such a super job of shepherding the economy into high clover that they could take a break without worrying about the wolves of Wall Street.
They announced to the world that they were going to take a break… go down to the bar… and have a drink.
Instead of supporting stocks and bonds with quantitative easing (QE, i.e., injecting cash into the system) and ultra-low interest rates, the Fed has begun quantitative tightening (sucking cash out of the system) and raising rates.
Somehow, the Fed’s wonks had known the world would be a better place with lower rates and QE in full swing. Somehow, they now knew the world would be a better place with higher rates and QE in reverse.
We told our Diary readers at the time that we didn’t think the Fed would follow through on its promise.
As soon as the wolves of Wall Street dragged away a few of the flock… it would be back on the job of inflating asset prices.
And that’s what happened last December, after a 20% tumble for the Dow.
Then Fed chairman Jerome Powell – aided by some incoming fire from President Trump’s Twitter account – got the message.
He took the podium and said the Fed would have to reconsider its previous position… and press “pause” on rate hikes.
Now, it’s putting its thumb on the scales once again. In what the press are calling an “insurance cut,” he slashed rates for the first time in 10 years.
That’s the way it works. The Fed is not just fallible; it is also foolish.
It predictably makes the three same mistakes. First, it keeps rates too low for too long. Then, realizing its error, it raises them, causing a serious allergic reaction on Wall Street.
That’s when it commits Mistake No. 3: It then gives the markets more low rates.
And now, after so many years of the Fed favoring financial assets with EZ-credit policies, the financial world is particularly sensitive.
Even a small hike in rates last year sent Wall Street to the emergency room.
Which is okay with us. We don’t care about higher rates. Or lower rates. We just want honest rates.
Honest rates produce honest prices. Honest prices are what an economy needs to make the right decisions.
But that doesn’t stop the Fed…
It decides, by committee, where it thinks rates should be. Then it proceeds to make Mistakes 1, 2, and 3.
Ours is a minority view. Most people believe the Fed knows what it is doing.
Alan Greenspan, who chaired the Fed from 1987 to 2006, was lionized for making all three mistakes. Ben Bernanke, his successor, was lauded when he had the “courage to act” by making Mistake No. 3.
Then Bernanke’s successor, Janet Yellen, was acclaimed for making Mistake No. 1 for four years.
And now Powell – no fool – is sticking to the script. He’s been making Mistake No. 2. Now, he’s making Mistake No. 3.
The Fed can’t hold back the downturn forever.
Since the 1960s, there have been 140 rate cuts. Over that time, the U.S. has gone through 30 double-digit stock market plunges and eight recessions.
Come the next downturn, the Fed will swing into it again.
But this time, it won’t be able to commit Mistake No. 3, as it did in 1987, 2000, and 2008; it will lack the firepower.
With no choice, it will team up with the White House and Congress to resort to Mistake No. 4.
Rarely seen in civilized economies, Mistake 4 stirs dull roots like warm spring rain… and excites strains of catastrophe now lying dormant in the laboratories of Hell.
The Fed will fire up the money helicopters.
It will permanently emit money to promote purchases of goods and services by households.
We’ll even see the Fed buy up stocks, like Japan’s central bank is doing right now.
For the last 30 years, we have seen nothing but absurd and unproductive central bank policies.
But hang on to your hat: There are plenty more where those came from!
Regards,
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Bill Bonner
Cofounder, Legacy Research