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Posted 4/17/2006
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Does the Fed really 'know' whats going on?
If you think the Federal Reserve has a clue, read the transcripts from 2000. Their recipe then was the same as now: print money, print money, print money.
By Bill Fleckenstein
As folks count down to the May 10 meeting of the Federal Open Market Committee, the ongoing tough Fed/easy Fed debate will likely strengthen. Of course, it was "easy" to see where Kansas City Fed head Tom Hoenig stands, thanks to comments uttered in a recent speech: "We're very close to where we need to be."
That pretty much sums it up, in my opinion. The intense media focus on the Fed that we see daily is sort of ridiculous. When you take a step back, it's clear what the Fed is going to do, which is the same thing the Fed has been doing ever since Greenspan showed up -- print money, print money, print money.
Etiology of Fed idolatry
A variety of events -- including the collapse of Communism, Windows 95 and the explosion of world trade on the back of NAFTA -- conspired to give us a unique economic period in the 1990s. All the Fed's money-printing and the happy times that ensued (whose "due" bills would be redeemed many years later) made folks think the Fed was omniscient.
That people believe our central bankers know the right federal funds rate to run the U.S. and the world economy confers a sense of near-infallibility on them. What inspires that confidence is a bit of a mystery to me, since a plethora of data exist to illustrate Alan Greenspan's huge mistakes at almost every inflection point (points which I have chronicled many times in my daily column, as well as here on Contrarian Chronicles, though less often).
Traipsing through Greenspan's transcript
Speaking of everybody's "favorite" Fed chairman, I just can't resist taking one more shot at him -- prompted by the recently-released transcript of the Fed's 2000 deliberations. Readers may recall that during the stock-market bubble, Greenspan said it wasn't possible to tell if a bubble was indeed occurring.
Related news and commentary on MSN Money
Of course, we learned two years ago, with the release of the 1998 transcript, that the Fed actually had some sense there might be a bubble. At one point, Mike Prell, former head of the Fed's research and statistics division, suggested that we were experiencing something that bordered on what occurred during the infamous South Sea Bubble. As I have noted in the past, the Fed was less than honest about what it thought it saw.
In any case, the transcript shows that throughout 2000, Greenspan displayed no grasp of what a bubble might mean as it unwound. Perhaps that explains his ambivalence as to whether there was a bubble or not (which was why he talked from both sides of his mouth). To wit: At the May 16, 2000, meeting (soon after the stock market's April blow-off), Greenspan stated that the risks in moving the federal funds rate 50 basis points higher -- from 6% to 6.5% -- "are not very large, because I think the underlying momentum in the economy remains very strong."
That statement perfectly illustrates his cluelessness as to the damage that lay before him, which is why we needed 13 rate cuts and several tax cuts to jump-start the economy. Of course, what he did was precipitate a housing bubble -- which dragged up the economy, but not exactly to a sound footing.
He also opined: "What is going to happen in the future is probably going to be dependent on a number of developments that we really can't forecast." Don't you just love that? People credit him with the ability to see around a zigzag maze of street corners -- when in fact, he can't even analyze current events. One did not need a forecast to know what was going to happen when the stock-market bubble burst. One simply had to recognize that the bubble had burst.
Sanity, amid the malarkey
At least Mike Prell had the good sense to state at the May 2000 meeting, which was his last: "In the current cycle, there would seem to be the risk of a particularly large decline in the market, given that, by many conventional metrics, we experienced a speculative bubble of extraordinary proportions." Indeed we did.
I have no idea why Mike Prell resigned. Perhaps he just couldn't stand the duplicity any longer. Obviously, Prell's words fell on deaf ears, because his replacement, David Stockton, said in August 2000 that he saw no sign of "an appreciable dent in the demand for equipment and software. It just doesn't look like this boom is about to dissipate anytime soon." (Of course, that was the sector to be hit the hardest, because of the insanity that had preceded it.)
A different sentiment was voiced in October 2000 by William Poole, president of the Federal Reserve Bank of St. Louis, who's often thought of as the Fed's pre-eminent hawk (and is presumably a man of intelligence): "Is there something there [in tech disappointments] that those companies are seeing that we're not seeing?" Yes. Their businesses were collapsing.
When confidence comes undone ...
Current Fed members have left an enormous paper trail of their thoughts, almost none of which inspires confidence. Yet, confidence has been conferred on them. It's confidence in the Fed that underpins the stock market, the economy and the dollar. That confidence is going to be shattered at some point, unleashing enormous damage to all three. The clock is ticking. We just don't know exactly when the end-game will start.
But lest folks worry that the Fed might spot some inflation and continue raising rates, rest assured, there are many methods by which it can rationalize inflation away. First of all, the Fed and Wall Street love the convention of looking at "core inflation," which is another way of saying: Take out anything that's gone up in price.
Rationalization blooms in a Yardeni garden
And, even if the Fed can't strip the inflation measurement of all items going up in price, it has a built-in excuse, provided recently by economist Ed Yardeni: One must decide whether prices are going up because of "excess demand" or supply disruptions. As Yardeni wrote in his morning piece April 11: "Raising interest rates when supply shocks may be the main reason for higher commodity prices could be a mistake, especially when there is no evidence that core-inflation rates are rising too." Got that?
His explanation: "Rising commodity prices resulting from supply disruptions -- rather than driven by demand -- may take the steam out of the global boom, and slow U.S. consumer spending and overall economic growth." See? Rising prices will correct themselves if they're due to supply disruption, an argument that he leans toward. (Rising prices couldn't possibly come from too much money-printing, could they?) The Fed need do nothing. Thus, I believe (for not just this reason, but others that I have articulated) that only one more rate hike remains in the Fed's quiver.
That said, I still think we could see data that would persuade the Fed not to even give us that much. If there is a nasty sell-off into earnings season, if we do in fact see some negative economic data, coupled with problems in the real-estate market (none of which would shock me), the Fed might be inclined to stand down on May 10. Either way, the rally that we get when the Fed decides it's done will be the last one before serious downside action occurs.
Two-year note makes nice music
Lastly, a memo to all savers: I think you could do a lot worse than owning a two-year Treasury note for two reasons: - It pays a rate of return that's at least close to the rate of inflation.
- When Fed Bennie panics, the note stands a chance to rally, even if the longer end of the curve continues to head south.
Bill Fleckenstein is president of Fleckenstein Capital, which manages a hedge fund based in Seattle. He also writes a daily "Market Rap" column on his Fleckenstein Capital Web site. His investment positions can change at any time. Under no circumstances does the information in this column represent a recommendation to buy, sell or hold any security. The views and opinions expressed in Bill Fleckenstein's columns are his own and not necessarily those of CNBC or MSN Money.
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