James Grant is disgusted with the Fed.
The founder of Grant’s Interest Rate Observer — and Ron Paul’s chosen replacement for Ben Bernanke — explained why at an event co-sponsored by the DeGrooote School of Business and Horizons ETFs in Toronto on Thursday.
By keeping interest rates so low, Grant says, Bernanke isn’t helping ordinary Americans.
“What we don’t see in the statistics is the demoralization of the 20-somethings. The monetary policy the Fed is pursuing is immoral, because it benefits the rich.” The Fed hopes raising asset prices will result in an eventual hiring spree, but he says that’s unlikely.
He points to five areas where U.S. policymakers are getting it wrong:
1. Devotion to neo-Keynesian policies
The Fed uses modelling that “some regard as intellectually suspect” – specifically, the dynamic stochastic general equilibrium model. He says it doesn’t take into account the possibility of Black Swans and unintended consequences.
2. Singular focus on the Great Depression
Policymakers always hearken to the lessons of 1930s monetary policy, but “there are other cyclical occurrences worthy of study,” he says. For instance, during the 18-month depression between 1920 and 1921, production fell 30%, wholesale prices fell 37%, and unemployment went from 5% to almost 9%.
The Fed solved it by balancing the budget and raising interest rates at the trough from 6% to 8% — distinctly different from today’s approach. As a result, production rose 60%. “But you never hear about that depression,” laments Grant.
3. Overriding the price mechanism
Even though Bernanke has stated he’d never interfere with prices, Grant charges that manipulating interest rates is the same thing, calling it “a remarkable demonstration of arrogance.”
4. Deflation as a red herring
While Grant agrees with attacking deflation, he’d like the Fed to attack the right kind. Prices fall due to globalization and technology, which is good. But he remains concerned because the Fed isn’t distinguishing between technological progress that makes certain goods cheaper and true deflation, which occurs when prices for a majority of goods drop in response to mass unemployment or excess supply.
Plus, low rates are spurring companies to increase leveraging activities, and that behaviour can spark another debt crisis, he says.
5. Too much regulation, not enough consequences
American capitalists are in for the upside, but not the downside, he says. Bankers don’t deserve Dodd-Frank; instead, they need to face financial penalties for their actions.
Grant says investors must realize there’s no such thing as a risk-free asset, and cautions against government bonds. He’s bullish on gold, but only because it moves opposite to sentiment about government intervention like QE and Operation Twist.
He calls the issues policymakers are focusing on as “the Y2K of today,” and stresses a need to shift attention to solving longer-term problems. “The real fiscal cliff is the moment in which the markets recognize the deficit that matters is not $1 trillion, but the present value of future unfunded promises,” he says. “That’s in the realm of $80 trillion.”
As for Canada, Grant’s a fan of the BoC. He approvingly calls our 1% interest rates “alpine,” praises our contracting balance sheets, and appreciates the fact that our governor is a suave celebrity.
His message to the BoC? “Don’t change a thing.”