Monday, September 28, 2015

Evidence Of The Fed's "Third Mandate"...........

Evidence Of The Fed's "Third Mandate"

If there's one lesson the world's central planners should have learned by now, it's that using monetary policy to micromanage economic outcomes leads directly to crises. 

Make no mistake, that's not some theory that can be written off as a one-line rant by an angry sound money advocate. It's a demonstrable fact, and the truly scary thing about it is that not only do central bankers steadfastly refuse to understand it, they ardently believe the exact opposite to be true. 

Indeed, the headlong plunge into unconventional monetary policy in the wake of the financial crisis quiteclearly indicated that Ben Bernanke either did not understand, or more likely, understood fully and just didn't care, that the Greenspan Fed played an outsized role in creating the conditions that led directly to the housing bubble.

The problem with rushing to combat any sign of economic or financial market turmoil by resorting immediately to counter-cyclical policies is that the creative destruction that would normally serve to purge speculative excess isn't allowed to operate and so, misallocated capital is allowed to linger from crisis to crisis, making the next boom and subsequent bust even larger than the last. 

This is one of the most important dynamics to understand when seeking to explain why the past two decades have seen the world careen from one crisis right into another and then into another with each one more terrifying than the last. 

For those who need proof of the above, we present the following chart from RBS which shows that even if one wants to argue that Keynesian tinkering can manage to slightly smooth out the business cycle (and trust us, the jury is still out on that), what it most certainly cannot do is smooth out financial cycles (defined by the IMF as "self-reinforcing interactions between perceptions of value and risk, attitudes towards risk and financing constraints, which translate into booms followed by busts"). In fact, what the following demonstrates is that central bankers are actually engineering huge booms and busts and getting better at it all the time:

We suppose the only saving grace here is that with rates glued to the effective lower bound across developed markets and with central bankers literally running out of monetizable assets, the Keyneisan endgame looks to be just around the corner and when it comes, it will be accompanied by a dramatic readjustment and, we can only hope, the return of some semblance of sanity.

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