Monetary Policy at a Crossroads

How Now Goes the Fed?

For nearly a decade, the Federal Reserve was largely on the sidelines. After reducing interest rates to close to zero in the wake of the Great Recession, they were reduced to less powerful weapons. In this period they adopted “quantitative easing,” where the numbers are big but the effect less clear.

Now the Fed is back. They have repeatedly declared that the economy is sound and it’s time to “remove the punch bowl” before the party gets out of hand. While the U.S. economy is not booming, it’s the strongest it’s been in more than a decade and may well be gaining momentum.

Fed policy takes time to bring about the desired effects so it must act ahead of time and anticipate the future. Even so, the Fed relies on data and trailing information about the economy and so usually operates behind the curve. We ask the Fed to do the impossible — accurately foresee the future — and are disappointed, even hostile, when, as most often is the case, they err.

What are the chances that this tightening cycle will be successful and how will we judge that success? At the same time, the Fed plans to sharply trim its record four trillion dollar balance sheet.

As a conservative institution, as a committee, and as a seer, the Fed operates  with challenges and consensus as they try to steer the world’s largest economy on the narrow path of prosperity and avoid a recession.

We are on the verge of the longest expansion in history and the odds of the Fed triggering a recession soon are high. This need not be a disastrous recession and perhaps will be one that markets can shrug off with a short pause.

Nonetheless, the Fed faces difficult challenges as it tries to nurse this economy through a period of sub-par growth while avoiding calamity.


Hamilton’s Blessing

Interest in the U.S. national debt seems to have diminished. Its importance has not.

Even with extraordinarily low interest rates, interest on the debt takes up one out of ten dollars of federal expenditures. If rates rise to more normal levels, even if the debt stabilizes, interest on the debt could easily double or triple.

Recently we came across a book titled Hamilton’s Blessing about the history of America’s debt going back to the founding fathers. It’s instructive that in earlier years the debt ran up during wars and crises and in between times was paid down.

Except for three years at the end of President Clinton’s term, that hasn’t happened in more than half a century.

While not an imminent danger, no initiative in Washington shows promise for getting this problem under control. The Tea Party made some noise but disappeared during the great budget compromise of 2015, when spending ramped up again.

At the least, the government should be extending the term of the outstanding debt while rates remain extraordinarily low.

The debt need not be a crushing burden but needs to be dealt with in all its dimensions in an intelligent way before it becomes an insoluble problem.


The Sun Will Shine Again

The U.S. stock market is off to its worst start ever — down nearly 12 percent in just three weeks. Standard & Poors searched records back to 1897 and couldn’t find anything worse.

While the market has been drifting lower since summer — including a brief but scary decline in late August — this drop has seemingly come out of nowhere and is unremitting in its furor.

Yesterday, the Dow dropped 550 points by midday before rallying sharply. While there are always things to worry about, this seems to be the bear market about nothing.

The Chinese economy, the second largest in the world, may be getting unhinged. And the oil market has gone from boom to busted in 18 months but hey, nobody’s perfect.

If it weren’t for these minor issues, the outlook might seem bright. Job growth has been strong in the U.S. and corporate balance sheets are in the best shape in years.

Worldwide, corporations and investors are awash in cash and looking desperately for places to stash it (no place more frantic than Colorado where legal marijuana growers can’t access the banking system).

So what’s an investor to do? It’s usually best to hunker down and not panic. And if you feel like panicking, turn off the TV and the Internet and take a walk. You’ll feel better and in the long run, your portfolio will thank you.


A Dark and Dangerous World?

For years I’ve felt like a lonely optimist in a dark and dangerous world.

In 2007, the U.S. economy was booming. House prices soared, unemployment was rare and anything seemed possible.

Then came the Great Recession, stock market collapse and the world financial system’s near failure. No one knew what to do.

Since that scary winter of 2009, the U.S. economy has rebounded. Car sales have doubled and housing starts quadrupled. The unemployment rate is half the recession peak.

Anecdotally, the pickup is dramatic. Help wanted signs have sprouted in store windows, trucks clog highways and realtors occasionally smile. The stock market has nearly tripled. For the first time in years, U.S. energy independence is possible.

Yet most Americans believe the country is on the wrong path. Only a month ago, the stock market plunged amid a weakening economy and troubles in China.

While problems never disappear, perspective is in order. U.S. GDP is up $3 trillion from the recession low to $17.4 trillion. The number of people with jobs in the U.S. is up by 10 million from 2009 to 148 million now.

Is everything perfect? No. But gloom and doom are overstated. After a scary drop in late August and September, the stock market rebounded and is flat for the year.

An investor must be an optimist and it’s possible they are at least partly right.


Budget Deficit Shrinking Fast

During the tumultuous political climate of the last five years, nothing has been more contentious than the U.S. budget deficit and government spending.

While Congress and the Administration have been fighting tooth and nail over this, shutting the government on several occasions and forfeiting the country’s AAA bond rating, something surprising has happened.

Both sides are bracing for a possible government shutdown again this fall and no one seems to notice that the deficit is fast disappearing.

Today, The New York Times reported in a small, single column story on the bottom of page B6 of the business section, that the deficit will shrink by 15 percent this year and by 75 percent since the first year of the Obama Administration.

As the economy healed from the Great Recession, taxes rose and spending has slowed and in some cases declined. A deficit that had reached a mind boggling $1.6 trillion is headed for $425 billion this year, down from $483 billion last fiscal year (the government year ends Sept. 30).

While still humongous in dollar terms, it’s not bad in an $18 trillion economy. After six years of spending austerity, the budget is now rising again, but still slower than revenues.

It’s not that there aren’t fiscal issues — entitlement spending still needs big changes and the government debt needs to be extended — but the fiscal crisis has ended long before the wrangling stops.


U.S. Budget Deficit Shrinks

The Dog That Didn’t Bark This summer the Washington Post had an article titled,” So Whatever Happened to the deficit?” Not quite a year ago, House Republicans threatened to shut the Federal government as part of their effort to lower the deficit. Meanwhile, while no one was looking, the deficit shrunk dramatically on its own. The deficit has shrunk from an unsustainably high $1.6 trillion in 2009 to an estimated $500 billion for the fiscal year that ends in a few weeks. The deficit will keep dropping as long as Congressional gridlock prevents new spending. Most economists consider the current level sustainable. Meanwhile, the economy has continued a five-year expansion. While the economy isn’t back to where it was before the Great Recession, this is a huge improvement from those dark days of late 2008 and early 2009 when the world economy threatened to collapse completely. As a result, the stock and bond markets have staged dramatic, if unheralded rallies. The stock market has nearly tripled from the bottom in March 2009 and the broad bond market is up more than 30 percent, according to Bloomberg. While none of this feels like a boom because it isn’t, the trends are good and investors shouldn’t be overly pessimistic.