In Defense of the US Federal Reserve’s Restoration of Price Discovery

In Defense of the US Federal Reserve’s Restoration of Price Discovery, by Charles Hugh Smith.

Having become addicted to the Federal Reserve’s nearly free money for financiers and the infamous Fed Put, stock market players are now weeping and thrashing about in the agony of withdrawal as Fed chair Jay Powell has instituted a cold-turkey withdrawal from the financial stimulus of the Bernanke-Yellen days.

Let’s be clear: the policies of nearly free money for financiers (QE) and the Fed Put were unmitigated disasters, as they distorted financial markets so severely that the markets’ pricing mechanisms have been crippled.

The policies of the Bernanke-Yellen Fed also directly exacerbated wealth-income inequality, as the wealth effect of rising equity valuations — the supposed goal of monetary stimulus — only benefited the top 5%, and most of the gains flowed to the top 0.1%.

Stripped of addictive stimulus and the backstop of the Bernanke-Yellen Fed Put, the markets are experiencing the pain of withdrawal and the traumatic return of price discovery.

Although we’re taught that capital has financial, intellectual and social forms, trust is also a form of capital, and thanks to the gross distortions and perverse incentives of the Bernanke-Yellen Fed, nobody trusts the market’s price discovery mechanisms any more. This is why market participants are so skittish and so easily panicked: they have no way of knowing what market valuations will be once the markets get through cold-turkey withdrawal from Fed smack and start discovering price via supply, demand, risk, cost of credit, discounting future cash flows, etc. — all the market mechanisms of transparent price discovery.

In effect, the Bernanke-Yellen Fed institutionalized the destruction of trust in U.S. markets in the pursuit of continued gains in equity valuations. Nobody trusted markets’ price discovery, but they trusted the Fed to bail out the stock market should any latent price discovery take markets lower. …

If we can dare to be honest for a moment, we’d confess that everybody knew the markets of the past decade were fake.

Since the GFC in 2008 the big financial “markets” have been heavily influenced by government manipulation. Prices have been fake. All assets were artificially pushed up in price — stocks and bonds, which flows through to real estate and collectibles — except precious metals, because higher prices there would indicate lack of confidence in government currency.

But the historic debt levels from the bubble of 1982 to 2008 remain. It has to be paid back. So attempts to wean markets off government support and back to honest price discovery will see some markets plunge to uncomfortably low levels.

Or maybe it’s political? Perhaps the deep state figures it will sink Trump by withdrawing government support for markets now, in time to trash them before the 2020 elections? Just reduce the rate of money supply growth to stall speed (5%) and nudge up interest rates, then just sit back and let markets work out prices in the new environment…

Jonathon Chait at MSN chortles about Trump’s coming comeuppance:

The long list of deep state operatives working covertly to undermine Donald Trump now includes numerous officials appointed by Trump himself. (This a testament to their deviousness.) The most recent is Jerome Powell, who chairs the Federal Reserve. Trump has complained to aides that his new antagonist will “turn me into Hoover” and privately inquired about firing him.

Herbert Hoover was the US President from 1929 to 1933. He is best remembered as ushering in the Great Depression, but this is unfair because it was the US Federal Reserve that caused both the 1920s bubble with a loose money policy and the subsequent Depression by allowing debt mechanics to take their course. US Fed Governor Ben Bernanke apologized for this a few years back.

Hoover implemented much the same responses as Roosevelt who followed. But the left credit only Roosevelt with getting the US out of the Depression — though all he did was prolong it with senseless socialist policies, until WWII finally got them out. Other nations got over the Great Depression much earlier.

Trump is furious that Powell, joined by the entire Federal Reserve Board, is slowly raising interest rates. ..

The president has relentlessly touted the recovery as the greatest ever. If Trump is right, of course, then this soaring rocket ship of a recovery which he has overseen — or, according to Trump, single-handedly engineered through his combination of corporate tax cuts and turning over regulatory enforcement to the business lobby — could easily withstand some small interest rate hikes.

Equally odd, Trump’s views on monetary policy did not line up with his public assessments of the economy during the last administration, either. When Barack Obama was presiding over essentially the same economic conditions, Trump derided it as “the weakest so-called recovery since the Great Depression,” with “94.3 million Americans outside the labor force.” This dismal analysis would imply that the Federal Reserve needed the lowest possible rates to sustain the recovery on its meager trajectory.

Trump was right about the economy when Obama was in power. He has been taking too much credit for rising stock prices while he’s been president, which is going to bite him now.