An Economic Conversational Debate Between Altrius’ Chief Investment Strategist, Jim Russo and a New York Technology Analyst Regarding Recent Federal Reserve Actions
Russo : How long are you going to hold onto the idea that a ¼% increase in the Fed Funds rate doesn’t matter? Capitalism is built on confidence and unfortunately our Federal Reserve is instilling little in the economy currently. Incredibly, some idiotic Senators yesterday were advising the Fed to continue to “normalize,” clearly misunderstanding simple economics.
Analyst : The Fed has inflated every asset category through its easy money policy and for the last year or two there's nowhere left to hide. Stocks are falling because they're overvalued, not because the Federal Reserve interest rate is higher by 25 basis points. The biggest detriment to continuing to prop up equities is the misallocation of human and financial capital chasing illusory business ideas. Didn't we see this with Greenspan failing to raise rates more quickly and the damage was worse as a result? In this case the overvaluations are narrower, but at least they're beginning to correct!
Russo : You are correct that monetary policy does inflate assets at times (as it did under Greenspan and Burns in the early 70’s); however, with commodity prices plummeting how can one assert that the Fed is inflating prices when deflation is clearly the problem? Keynesian economics (though I’m not a Keynesian) is the only solution under such circumstances though “pushing on the proverbial string” often only helps slowly and over time as confidence is restored.
I would agree that U.S. growth stocks are clearly overvalued; however, our U.S. stocks are selling at a reasonable 15 times earnings. International stocks are also fairly valued as they haven’t risen even closely to the levels of U.S. growth stocks. However, everything is selling off due to a loss of confidence and the Federal Reserve and Congress are not helping to instill confidence.
Analyst : There is merit to the "stave off deflation" argument, but it basically means we are screwed and deflation is coming thanks to global overinvestment using misguided judgement over the past several years. Too many commodity mines, too many factories, too many skyscrapers all built in the past few years will be the culprit for deflation, not miniscule upticks in interest rates. It would be good for the Fed to stave off macro fear, but someone needs to disincentive misguided investment as well.
Russo : I would argue that we are not in our current precarious position due to overinvestment in recent years as we have actually had dismally slow business investment and sluggish growth (< 2% GDP) has come in response to low demand from the global consumer. I believe you are confusing speculative investments in Silicon Valley with global economic demand as Silicon Valley actually makes up a tiny percentage of global growth.
Instead, the economy remains incredibly fragile as it slowly recovers from one of the worst recessions our nation has ever experienced – put in place by numerous factors resulting primarily from investor speculation and Wall Street leverage in CDOs leading to a collapse in confidence in the financial system – and secondarily to issues which led to the development of such products namely no capital gains taxes on primary homes, rating agency misjudgments, lack of regulation on investment institutions (Democrats are right here), encouragement of home ownership for all (Republicans are right here), et al.
As such, it will continue to take a concentrated monetary policy effort – particularly since fiscal policy continues to be a disaster. Tightening at a time of deflationary prices is an exceptionally incorrect policy and Republican Senators such as Toomey (whom I just heard speak during Chair Yellen’s testimony) are as wrong as Senator Shelby and others were when they advised against bailouts of the financial system…unless one enjoys bread lines.
Disincentivizing misguided investment will happen naturally as those investments fail and the Fed can better counter that by raising the margin requirement. Raising interest rates to pop a bubble in a very small sector is exceptionally misguided to the point that I’m sure Keynes is rolling over in his grave!
Analyst : Overinvestment in Silicon Valley is only a small part of the problem (although it has had a disproportionate effect on misallocation of human and financial capital).
At a global scale, there has been overinvestment outside the U.S. in commodity extracting facilities and manufacturing of consumer goods. This in turn fueled emerging market consumer consumption which gave U.S. and European names the illusion that demand was better than it actually is. The result is a vicious cycle – weak U.S./Europe spending impacts emerging market manufacturing/commodities, which weakens emerging market consumer demand that U.S./Europe on companies were counting on.
Russo : It is definitely true that there have been pockets of overinvestment in commodity extracting facilities and possibly consumer goods. However, companies have ramped up to meet demand and wouldn’t have done so speculatively without such demand. Now that China is moving from a manufacturing to a service based economy, the demand for commodities in waning some.
This is another reason why the Fed should absolutely not be raising interest rates at a time in which global demand for such goods is declining as this issue is deflationary. As inflation doesn’t exist in the economy, and demand is slowing, the Fed should have kept rates flat – if not continuing QE efforts.
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