The Fed is to Blame!

For what, you might ask?   For the mess the current financial system is in, and the wealth destruction that has ensued.

Well, in fact, we all are to blame in some interconnected way, but it is clear to me that actions taken by the Fed a decade ago have been the prime determinant for the path we are on.  They never should have cut rates to such low levels and allowed them to stay there for so long.  They never should have indicated stability in rates and “measured” changes.  They never should have reached for quantitive easing.

Low rates have led to misallocation of capital on a scale never before seen.  This has “forced” savers to reach for yield and make poor investments.  This has allowed people and peoples to borrow money hand-over-fist and spend it unwisely.  There is a fantastic quote from Michael Lewis’ article in Vanity Fair:

When you borrow a lot of money to create a false prosperity, you import the future into the present. It isn’t the actual future so much as some grotesque silicon version of it. Leverage buys you a glimpse of a prosperity you haven’t really earned.

Leverage buys you a glimpse of a prosperity you haven’t really earned.  This encapsulates the problem we have.  A decade of easy money not only allowed people to become over-leveraged but also gave politicians the tools to go out and make promises that can’t be met; whether they are in Greece, California, or my local town school system.  A bailout will only kick the can down the road for someone else to face.  Borrowing more to solve a debt problem is not a solution that can work for the long term, as the debt is not borrowed to supercharge growth.  We are now entering the Decade of Defaults as it becomes clear that there is no other solution.

Why are the authorities so wary of defaults?  Because it will wreck the banks, pension funds, insurance companies that own this debt and want to treat it as money good.  I suspect it would have been better to take the losses and re-cap the banks and start to explain to people that their pensions and other “entitlements” are not entitlements rather than continue the charade.  Politicians do not have the stomach for this – they, like investors, are increasingly myopic.

I am in a small minority, and it is increasingly clear that banks, politicians and regulators have interests that are mis-aligned to what is best for the rest of society – they will continue on with their make-believe asset valuations and hold onto power beyond any reasonable expectation.

Ultimately, there will be a reconciliation and such a reconciliation will be political as much (or more so) than economic.  Political reconciliation can sometime be peaceful and through the system, but often than not it is neither.  Don’t blame me when it happens, blame the Fed.

Postscript: The ECB is just as bad, given their capitulation this weekend.