The Fed Chairman tells the President that his administration must work with Congress to cut spending or else the Fed will begin reducing its balance sheet. The President thanks him for his years of service. The Chairman, concerned with his legacy of having been too accommodative, hints to the public about tapering the Fed’s asset purchases. The dollar rallies and asset prices fall.
Perturbed, the President then publicly thanks the Fed Chairman for his years of service. The Fed Chairman escalates, publicly setting a time frame when he’ll begin tapering. The markets fall even more dramatically. The President, fearful that the Fed’s actions could destroy his legacy, quickly names a replacement for the Chairman, one that reliably plays ball. The markets rally. Through the optics of the capital markets, the President successfully perpetuates the temporary appearance of a healthy economy.
The Fed Chairman returns to the private sector with dignity, his legacy defined by providing abundant credit when necessary and then trying to set a course back to normalcy. Yet the Fed never diverges from its accommodative posture; its zero interest rate policy remains in force and quantitative easing INCREASES to record levels. The capital markets rally further as the real economy continues to contract. Washington and Wall Street are happy while real output and employment continue to fall.
A crisis “no one could have foreseen” occurs. Financial markets plunge. Banks inform the Fed their loan books are deteriorating. The Fed triples QE and yet employment rolls continue to drop. The Fed informs Congress and the President that the monetary system must be reset. The public grows angry that, just like in 2008, banks and the government gained funding through newly created money but it, the public, did not. (Civil unrest?). The State Department concurs with the Fed; foreign exporters to the U.S. no longer want US dollars in exchange and the system must be changed. At the urging of the President, Congress directs the Fed to devalue the Dollar to gold, and to reset a fixed exchange rate.
Few still dispute that the capital markets are priced at the pleasure of elected and appointed authorities. The spectacle called “economy” should continue as-is, predictably reflexive, until it is in the interest of authorities to change its rules (not as predictable yet still entirely rational and quite in the American tradition). On and on it goes until it no longer can.
Moral: When the financial markets no longer reflect the human condition, authorities must answer to true power – the marketplace.
QB Asset Management Company, LLC, June 2013