The Big, Fat, Ugly Lie

Once upon a time, the prospect of rising rates spooked the share market.

We became accustomed to bad news being good news.

The Fed raised the cash rate 0.25% yesterday, and telegraphed another three 0.25% increases in 2017.

What was the market’s response?

Dow closed up 80 points overnight.

The US 10-year bond rate edged higher to 2.6%

Gold continues to be unloved. Falling to US$1130.

According to Bloomberg the reasons for the Fed’s rate decision and forward guidance is:

Federal Reserve officials raised interest rates for the first time this year and forecast a steeper path for borrowing costs in 2017, saying inflation expectations have increased “considerably” and suggesting the labor market is tightening.

If in fact the Fed’s improved outlook for 2017 is correct, it’s been a long time coming.

The Wall Street Journal put the latest rate increase into perspective with this graphic.

Source: Wall Street Journal
Click to enlarge

An interest rate hill followed by a barren stretch of near zero-rates.

For eight long years, the only ‘saving’ the Fed’s been interested in, has been saving borrowers. The Fed has deliberately and wilfully sacrificed savers to achieve this objective.

Asset prices, along with debt levels, have soared from this warped and twisted economic policy.

During the US Presidential campaign, Donald Trump called it correctly on September 26, 2016 when he said, ‘Believe me. We’re in a bubble right now. We are in a big, fat, ugly bubble.

We’ve seen the two previous movies in this a big, fat, ugly bubble trilogy — the tech bubble and the housing bubble. Both were directed and produced by the Fed.

The Fed’s (and all central bankers’) actions are driven by one objective and one objective only: do anything and everything to encourage consumption (preferably debt-financed) over productive investment.

Savers must be punished, borrowers are to be rewarded, instant gratification encouraged (buy now, pay later!), and the illusory wealth effect maintained in order to keep consumer confidence readings in the positive.

This is the central banker game plan…pure and simple.

When this big, fat, ugly bubble bursts, this is what the review might say:

The roots of the financial crash stretch back to the preceding seven years of low interest rates and high world growth. On one side, macroeconomic forces were at work, as low interest rates prompted investors around the world to search for yield further down the credit quality curve, and high growth/low volatility led them to overoptimistic assessments about the risks ahead. On the other side, and partly in response to the demand, the financial system developed new structures and created new instruments that seemed to offer higher risk-adjusted yields, but were in fact more risky than they appeared. In this setting, market discipline failed as optimism prevailed, due diligence was outsourced to credit rating agencies, and a financial sector compensation system based on short-term profits reinforced the momentum for risk taking.

Oh wait, my apologies. That review has already been written.

In fact, this is an extract from the IMF research paper Initial Lessons of the Crisis published on 6 February, 2009.

What’s been learned from those initial lessons?

Is it a comedy or a tragedy that absolutely nothing has been learned from the hardship of the last bubble’s bursting?

And 2008/09 was no ordinary garden variety recession. Don’t take my word for it, this was from a speech made yesterday by President Obama:

Eight years ago when I took office, our economy was in crisis. We were just months into the worst recession since the Great Depression, with unemployment rising rapidly toward a peak of 10 per cent,

The worst recession since the Great Depression…got that.

Call me silly but if I had a near death experience, I’d make damn sure not to repeat the mistake that caused it again. But here we go.

The same ingredients are at play today as existed before 2008 — seven years of low interest rates; investors searching for yield in high risk investments; overoptimistic assessments of future risks; more derivatives; more collateralised offerings; fudged earnings figures to drive short term profits up, to trigger bonuses.

These ingredients do not bake a different cake. They bake the same big, fat, ugly bubble cake that was shoved down investors’ throats in 2008. Only this time the cake is bigger, fatter and uglier than it was then.

The Fed and Obama tell us ‘the labor market is tightening. In part this is due to the participation rate — people working or actively looking for work — steadily falling since 2008…from 66% to 63%.

People have given up looking for jobs and migrated to welfare. That takes care of 3% of the unemployment problem.

As for the rest?

For those participating in the workforce it’s a mixed bag of winners and losers. The Wall Street Journal delved into the data and concluded:

…were all the jobs we created since the recession bad? Well, yes and no. It’s true that many low-wage industries have been growing, many middle-wage industries have shrunk, and more people work part time or for minimum wage than did a decade ago. But it’s also true many middle- and high-wage industries are growing too, and the number of minimum wage and part-time workers has gradually been declining over the past five years.

Compared to the depths of the 2008/09 recession, employment prospects have improved slightly…but you’d hope that’d be the case, after all the extraordinary stimulus measures and increased borrowings.

However, when compared to the pre-2008 period, there’s been a noticeable shift towards lower–paid, part-time employment.

The same trend is happening in Australia.

The Australian August 20, 2016:

Employers use a myriad of means to reduce labour costs. Whether it is hiring more juniors, casuals, part-timers, trainees or migrants on short-term visas, the drive to remain competitive through cheaper and more flexible labour hire can be seen throughout the economy. Industries that rely on low-skilled jobs, such as retail and hospitality, are prime examples of this trend.

The headline numbers may show an improvement, but the detail reveals a deterioration in the overall quality of employment and level of remuneration. More losers than winners.

And there’s more bad news coming for those underemployed and underpaid workers…

Source: Econdataus
Click to enlarge

Those left in the workforce are going to shoulder a much greater welfare burden than previous generations.

The other reason for the Fed raising rates this week and possibly next year is inflation expectations.

Perhaps there might be a temporary inflation spike as a result of debt-funded Government spending, but it will be countered by very powerful and persistent deflationary forces.

  • Workers facing wage pressures from globalisation and automation.
  • More boomers moving into retirement and trying to live off a modest capital base earning ‘3/5ths of 5/8ths of bugger all’ (an old saying of my Dad).
  • Governments cutting back on welfare payments because those two or three workers supporting one retiree say ‘enough is enough’. They’ll deliver the ultimatum ‘either you cut back the entitlements, or I’m leaving the workforce to join the social security queue.’
  • And lastly, the capital devastation caused by the bursting of the biggest, fattest and ugliest bubble since the Great Depression will herald a new era of prudence towards money management. The cavalier days of debt, debt and more debt will be consigned to the history books.

We have been living a big, fat, ugly lie.

Given the Fed’s appalling record in reading the economy correctly, I suspect the recent rate rise is a case of way too little, far too late.

2017 could well be the year the truth is exposed.


Vern Gowdie,
For Money Morning

Vern is a contributing editor to Money Morning — Australia’s biggest circulation daily financial email. (To have Money Morning delivered straight to your inbox you can subscribe for free here).

Vern has been involved in financial planning since 1986. In 1999, Personal Investor magazine ranked Vern as one of Australia's Top 50 financial planners. His previous firm, Gowdie Financial Planning, was recognized in 2004, 2005, 2006 & 2007, by Independent Financial Adviser (IFA) magazine as one of the top 5 financial planning firms in Australia.

Vern has been writing his 'Big Picture' column for regional newspapers since 2005 and has been a commentator on financial matters for Prime Radio talkback. His contrarian views often place him at odds with the financial planning profession. In his leisure time Vern remains active with triathlons and pilates.

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