When The Fed Creates Money, Who Gets It?

Source: AP Photo/Jacquelyn Martin

The stock market rocketed recently on news that the Federal Reserve may cut interest rates. People speculated that it may do so because of tanking economies in the rest of the world, President Trump’s trade wars, the slowing US economy, and other ideas.

Central banks have used the tools of interest rate changes and open market operations (buying and selling treasuries) for over a century in misguided efforts to boost their economies out of recessions. They get by with it because the process is complicated enough that most people don’t understand it. The general idea is to force feed the economy more money through the tube of the banking system.

No Rate Increase in 2015

Mainstream economists and financial experts warned us early in 2014 to stay way from bonds because the Fed would raise interest rates and as everyone knows rising interest rates shoot buckshot-sized holes in bond portfolios. So most people avoided bonds and piled into stocks. Now we can look back and see that conventional wisdom was wrong; the Fed did not raise interest rates; inflation remained tame; and bonds returned about twice the money as stocks.

Now the mainstream has dusted off its forecast of rising rates and is trying again. Surely this is the year the Fed will raise rates and kill bonds. After all, the Fed has always raised rates at some point in an expansion. How can it not raise them in this one?

Plucked Chickens, MMT and Investing

Plato once defined man to his followers as a featherless biped. Diogenes heard it, caught a chicken and plucked it then brought it to Plato saying, “Here is your man.”  I got that story from Jack Sparrow at the Mercenary Trader.

Was Plato wrong? No. Most men walk on two legs and most of us don’t have feathers, but that is a very simplistic model of what constitutes mankind and as a result has very limited application. The humor in the story comes from Diogenes stretching the model beyond its ability to describe the real world and drawing wrong conclusions.

Plucked chicken modeling happens in economics on a regular basis. Economics is about modeling complex events. If the model is too complex it becomes unwieldy and few can understand it. The trend in economics over the past century has been to create extremely simple models. The assumption of equilibrium that forms the foundation of mainstream economics is the most egregious example.

Swedes help with timing

Anyone not a mainstream economist has recognized the awesome blindness of the profession to the approach of the latest financial crisis and its impotent policies afterwards. I recently finished a book published last year that not only explains why mainstream economics failed but promotes good economics, the Austrian kind, and provides another tool for telling the future.

Thomas Aubrey, the author of Profiting from Monetary Policy and founder of Credit Capital Advisory in the U.K., consults businesses on how credit creation affects global asset prices. Aubrey begins by detailing the devastation of the crisis on pension funds. Not only did many funds lose money in the crisis, but the low interest rate monetary policies intended to restore the economy have inflicted more damage and will lead to many failing in the future. Aubrey doesn’t mention the life insurance industry, but it and millions of retired people are suffering for the same reasons.

QE to Infinity and Beyond and Cantillon

Mainstream economics denies that Cantillon Effects exist. Cantillon Effects are one of those insights that Austrian economics offers followers that help us avoid nasty surprises like the Great Recession. Recently, McKinsey and Company provided research that supports the Austrian view of Cantillon effects from QE. Here is one of their charts:

Krugman advertises ignorance

ABCT Investing is based on the Austrian business cycle theory, so I become mildly concerned when others criticize the theory. I never become seriously concerned because I have learned over the years that most critics are unbelievably lazy. If they bother to read Mises or Hayek they do so through the lenses of mainstream econ and fail to understand what the authors are actually saying. 

The Social Democracy blog has posted a long diatribe against Ludwig von Mises, which I would normally ignore had Paul Krugman not advertised it. Krugman even gets wrong much of what the blog says, but the blog gets a few things wrong so here are my responses:

Natural rate of interest

The blog is right that the “natural rate” of interest doesn’t exist. Of course, neither does “equilibrium.” Both are theoretical constructs to help us think about economics. Wicksell defined the natural rate as the rate of interest in a barter economy. Interest would exist if we were forced to barter goods because interest is nothing but the opportunity cost of giving up the use of something for a period of time. Austrian economists picked up on the idea as a useful way to explain how interest under barter differs from interest using money. It’s a teaching devise. But if you don’t like it you can ignore it. It helps teach the ABCT, but has little importance to the working of the theory.

Mises and fascism

Fed Fail!

With Ben Bernanke's departure, it’s time to grade his portfolio of work. Ben invented new methods to expand the money supply, including buying non-government issued debt. Mainstream economists credit him with having rescued the economy from the latest recession. The economy has recovered slowly in the past five years, but should we give all the glory to the Fed? These charts should answer those questions: 

What is ABCT Investing?

Almost everyone has a blog today, so why would I bother to add my teaspoon to the deluge? I did so because I found a hole in conventional investing wisdom which I think needs plugging. I’m not the little Dutch boy who stuck his finger in the hole in the dam and saved the village below. But I think I have a perspective on investing that few others share and which could help people rescue their nest eggs from tragedy.