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The Fed Fiddles at Jackson Hole

Posted August 22, 2016

This week, on August 25–27, the whole pack of economists and policymakers will be hanging out in the mountainside resort of Jackson Hole, Wyoming. It’s time for the annual economic symposium.

The topic on hand, named as only a bureaucrat can, is “Designing Resilient Monetary Policy Frameworks for the Future.”

By which they mean when the SHTF, they will print more money. But much like in Vietnam, we had to burn the village in order to save it, or in the case of Obamacare, we had to pass the bill in order to know what was in it.

The Fed must hike rates in order to have rates to cut during the next downturn. The bad news is that hiking rates will cause the next downturn...

But that is neither here nor there. Yellen and her kin at the Fed are smarter than you are. You might think that when you are in debt up to your ears, you stop spending money. But Yellen believes that when faced with a debt crisis, you create more debt.

The idea is that debt will fund investments and spur animal spirits. The facts have proven that what happens is leaders of companies take on debt and buy back their own shares. This reduces shares outstanding and increases earnings per share. This, in turn, drives up the share price and enriches those in the C-Suite.

The downside is that it ruins the balance sheet and doesn’t make the company stronger, as the debt goes to buying shares at the top of the market instead of investing in plant and equipment or R&D.

Bill Gross recently wrote:

Are near-zero interest rates and a global store of about $13tn worth of negative-yielding bonds actually good for the real economy? Recent data suggests they may not be. Productivity growth, perhaps the best indicator of an economy’s vitality, is abysmal in most developed countries. It has been declining in the past half-decade or so, not coincidentally tracking the advent of QE and zero lower bound interest rates.

In the US the year-on-year trend for productivity has turned negative. Most central bankers dismiss this fact as a short-term aberration. But the Japanese economy provides an example of what interest rates at or near zero can do to a large, developed economy. The answer is not much: not much real growth; not much inflation — and, together, not enough nominal GDP growth to repay historic debt should yields on sovereign debt ever return to normal.

Corporations are using an increasing amount of cash flow to buy back shares as opposed to investing for growth. In the US, more than $500bn is spent annually to boost investors’ incomes rather than future profits. Money is diverted from the real economy to financial asset holders — where in many cases it lies fallow, earning little return if invested in government bonds and money markets.

Historic business models with long-term liabilities — such as insurance companies and pension funds — are increasingly at risk because they have assumed higher future returns and will be left holding the short straw if yields and rates fail to return to more normal levels.

The profits of these businesses will be affected as will the real economy. Job cuts, higher insurance premiums, reduced pension benefits and increasing defaults: all have the potential to turn a once virtuous circle into a cycle of stagnation and decay.

Central bankers are late to this logical conclusion. They, like most individuals, would prefer to pay later than now. But, by pursuing a policy of more QE and lower and lower yields, they may find that the global economic engine will sputter instead of speed up. A change of filters and monetary policy logic is urgently required.

Yellen at J-Hole

Despite all the evidence saying stimulus doesn’t work, the global central banks continue to push free money out the door. The U.S. continues to give lip service to hiking interest rates. But of course they won't. It was only six months ago when they were saying there would be four rate hikes in 2016.

No one believes they will hike rates in September, though this week they will try to scare the market down by saying it's a possibility. There is a good chance this will work, as it has worked every other time the Fed has threatened a rate hike.

This should push the dollar up and equities and commodities down.

After Yellen speaks on Friday and pushes the threat of a rate hike to December, the strong dollar trend will reverse and commodities like oil, gold, and silver will take off into September/October.

Right now, oil companies are just coming off of multi-year lows. Rig counts in North America have turned and are moving up slightly. The bottom is in, but it's not too late to profit.

All the best,

Christian DeHaemer Signature

Christian DeHaemer

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Since 1995, Christian DeHaemer has specialized in frontier market opportunities. He has traveled extensively and invested in places as varied as Cuba, Mongolia, and Kenya. Chris believes the best way to make money is to get there first with the most. Christian is the founder of Bull and Bust Report and an editor at Energy and Capital. For more on Christian, see his editor's page.

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