We went to dinner last night at a little neighbourhood restaurant in Palermo Soho.
It was already crowded when we arrived after 9:00pm., with a warm buzz of conversation.
But scarcely had we been there 10 minutes when the diners fell silent.
A woman at the table next to us was choking. She stood up, bent over…pointing to her throat and gagging.
Her companions stood up. The waiter rushed over. But no one seemed to know what to do. They held her arm. They patted her back. But she was still gagging and seemed to be ready to pass out.
What to do?
We wrapped our arms under her ribs. We have never actually seen the Heimlich manoeuvre performed…and had heard that it doesn’t work. But time was running out.
We formed a fist and jerked it up under her ribs.
Miracle! She spat out a piece of meat…stood up…and thanked all around her.
Then we all sat down and gradually, the conversation resumed.
No more free money
Meanwhile back in the markets…yesterday, Jerome Powell spoke to Congress for the first time as head of the Fed.
And he spooked investors by hinting that interest rates might be on the rise faster than expected.
Reuters was on the case:
‘Fed Chairman Jerome Powell pledged to balance the risk of an overheating economy and the need to keep growth on track in his prepared testimony. But Powell’s remark that inflation has strengthened since December sent yields higher and stocks lower.
‘The [yield on the] 10-year U.S. Treasury, the global benchmark for commercial lending, jumped past 2.9%, and equity markets in Europe and Wall Street turned south, with MSCI’s key index of global equity performance falling 0.4%.’
The three major indices on Wall Street fell.
Yes, Dear Reader, the Fed giveth. And the Fed taketh away.
Ever since Alan Greenspan slashed interest rates in response to the 1987 stock market crash, we’ve been watching the Fed give what appeared to be free money to the financial economy.
Now, it seems to be taking it away.
Mr Powell says the Fed plans to take back some $2 trillion over the next three years.
On the one hand, everything is as it has been for nearly three decades.
The Fed still believes it can manage the economy.
It thinks it knows what interest rates should prevail…and what stocks should sell for…and where consumer prices should be.
But all the evidence and sensible theory is against them.
The likelihood that a few PhDs will find exactly the prices that the economy needs is remote. The Soviets proved they couldn’t do it. The Chinese couldn’t do it, either. Nobel Prize winner Friedrich Hayek explained why no one can.
That’s the beauty of a free market economy: It doesn’t require quack economists who claim to be able to do impossible things.
A planned economy will work properly only if the planners know what the hell they are doing.
A free market economy can work well in total ignorance. Markets discover new prices every day. No one needs to know the answers in advance.
But the geniuses at the Fed deny it. They claim they can do what no mortal has ever done: impose their judgment on the markets and make the economy better than it ever would have been without them.
Wolves of Wall Street
For their part, investors don’t question it.
They still believe the Fed has their backs, as it has had for more than a generation. The buy-the-dip mentality still seems to be a great way to make money.
Until it isn’t…of course.
Which is what happens when the Fed changes course…or runs out of claptrap.
Yes, that is where the other hand is. That is the big change.
The brains at the Fed now believe they have done such a super job of shepherding the economy into high clover that they can now take a break without worrying about the wolves of Wall Street.
They’ve announced to the world that they are going to take a break…go down to the bar…and have a drink.
Instead of supporting stocks and bonds with quantitative easing (injecting cash into the system) and ultra-low interest rates, the Fed has begun quantitative tightening (sucking cash out of the system) and raising rates.
Somehow, it knew the world would be a better place with lower rates and QE in full swing. Somehow, it knows it will now be a better place with higher rates and QE in reverse.
What are investors thinking?
That the Fed doesn’t mean it? That it won’t follow through? Or that higher rates won’t affect their stock portfolios?
We don’t think the Fed will follow through, either. But it won’t get back on the job — inflating the markets and the economy — until the wolves have dragged away a few of the flock and the rest are running for cover.
That’s the way it works. The Fed is not just fallible; it is also foolish.
First, it makes mistakes. Second, it tries to correct its mistakes with more mistakes. And third, when it sees what a mess it has created, it reverts to the first mistake: It cuts rates…and holds them down too low for too long.
Then it raises them…and the economy goes into recession. It cuts again. Raises again. And then, it must cut again.
Or try to.
The 10-year Treasury note yielded nearly 10% on Black Monday in 1987. It yielded over 6% when the dotcom bubble blew up in 2000. And it yielded just under 5% when the subprime mortgage crisis hit in 2007.
But today, the 10-year note yields 2.9%, which doesn’t leave the Fed much to work with.
So Chief Powell is making the second mistake now. He is eager to get yields higher before the next crisis hits. Then, he’ll have something to make the first mistake with.
But raising borrowing costs is bound to set off the next recession/crash.
As we reported yesterday, our Doom Index is at an ‘Extreme Warning’ level.
Disaster could strike any day…as soon as investors realize that Mr Powell is sneaking up on the bubble with a pin in his hands.
For Markets & Money