Dear Federal Reserve:
As we approach your last get together of the year I first want to wish you all great holidays and a happy and healthy new year. I also want to extend my utmost respect for the time you have given to public service in your contribution of what is the Federal Reserve system with the best intentions. But, as they say with the best intentions, it leads to roads unforeseen to put it nice. As it is year end it’s always a good time for reflection and let’s look in the mirror together.
The predominant investing rallying cry over the last 15+ years of the ‘Greenspan (now Fed) put’ and ‘search for yield’ without regard to risk is again showing its darker side, this time in the energy patch. We of course saw it first in technology land in the late 1990’s, to be repeated in a different fashion in the mid 2000’s via credit and housing and now in the US oil and gas industry. Thanks to those two sayings, the US economy has become the US ‘boom and bust’ economy. Your sole focus on consumer price inflation has again shifted your attention from the negative repercussions of excessive asset price inflation that inevitably always mean reverts. This time, an epic bond bubble is showing some big time cracks in corporate land.
Without rehashing the two previous bubbles, let’s talk about the new one and focus on the ‘search for yield’ without regard to risk syndrome that again created extreme asset price inflation and again got hold of parts of our economy. Via another one of your cycles of interest rates well below the rate of inflation, the manhandling of longer term interest rates with QE and amazing American ingenuity and technology, anyone with a drill bit and a land lease was able to get a loan as long as oil prices levitated north of $80. Bloomberg estimates that since early 2010, $550b loans and bonds were issued by the oil and gas industry. Give me yield or give me death was essentially the mantra for this and many other investments. And, the money kept flowing, the drilling kept coming and all of a sudden the spurt in supply bumped up against a slowing global economy and then poof. The bubble burst essentially in a crash with crude prices falling by 46% over the past 6 months, not coincidentally either just as QE was ending.
Which brings us to another one of your meetings this week where the debate now and for 2015 is when and how do you normalize interest rates and whether your focus should be the better labor market and the improvement in wage gains in November or more so the sudden drop in commodity prices mostly driven by lower oil prices. The irony of this discussion though hopefully won’t escape you. Cheap money that you created fueled a drilling boom that oversupplied a market that now has shrinking demand. Now with lower oil prices, headline inflation and inflation expectations as a result, you may actually use low inflation as an excuse to keep rates low for longer, the same policy that previously created the boom and now the bust. In your desire for higher inflation, cheap money instead lead to malinvestment and over capacity that inevitably lead to a downside and lower prices.
Those fiber optic cables would have been laid anyway, those homes would have been built anyway and those shale wells would have been drilled anyway but the ‘Fed put’ and ‘search for yield’ rallying cries brought so much of this activity together at once in their respective time periods that the boom it created inevitably lead to the busts that followed. You know excessively easy monetary policy not only buys time, it steals economic activity from the future. Buy and invest today maybe what you would have done tomorrow but tomorrow always comes. Why isn’t this lesson ever learned?
I will sum up with this: history is replete with the bad economic consequences of trying to manipulate human behavior with government induced price controls. Over the last 15 years especially it’s been control over the price of money and current policy is as if we have an economic five alarm fire. I’m not calling for you to quickly normalize policy immediately. I just believe that the process must begin, however slowly, as soon as possible and asset price inflation should no longer be ignored or only acknowledged with vague comments about overvaluation in select asset markets. Words and macro prudential regulation are not going to do it. The path ahead will be disruptive but that can no longer be avoided as 6 years of ZIRP and a 5 fold increase in your balance sheet has already way overstayed its welcome. The longer you wait, the worse the consequences will be when you do. Again, happy holidays and happy 2015.
Managing Director and Chief Market Analyst, The Lindsey Group LLC