Market to Fed: "Who Cares?"
In yet another futile attempt to fix a mess which they have long since lost control of, the Fed cut rates for the 12th time in a row last week. Hoping to light a fire under the market and the economy, the "wise old bankers" surprised us with an additional 25 bp slash, above and beyond the expected 25 bp. The market greeted the "good news' by falling sharply for the next few days. An astute observer could readily conclude that the market isn't quite as dumb as Uncle Al might have hoped.
There was a time when the market greeted rate cuts with enthusiasm and optimism. But the market has since grown a bit wiser. It has become fairly obvious that when Uncle Al mutters "things are OK and about to get better" while simultaneously cranking on the rate cut lever 12 times in a row, something must have run amuck. There has been a huge disconnect between what the Fed has been saying and what the Fed has been doing. You can fool some of the people some of the time, but you can't fool the market for two years running.
Twelve rate cuts later, the market is hovering only moderately above multi-year lows. Why? Because the market is painfully aware that the Fed is not, in fact, a tight-lipped circle of financial geniuses able to single-handedly create whatever effects they desire in the economy. As always, the economy and the markets are BIGGER than any man, bigger than any cabal of bankers. The market has lost faith Uncle Al can even engineer a successful tying of his shoelaces, let alone a financial recovery.
To be sure, under certain conditions and during particular times manipulations of interest rates can and do have great implications and results in the marketplace and the economy. Witness the "go-go" years of the 90s when the Fed could apparently do no wrong. (But then, as market veterans know, EVERYONE is a genius in a BULL market and a strong enough wind can bless even the fattest of turkeys with the gift of flight.)
But sometimes things get a little more complicated. Say, for example, times following the implosion of huge economic and asset bubbles.
Wall Street wasn't particularly excited about the most recent easing because let's face it: if you've cut rates eleven times and 4.75% and it's still not making a difference, is another 50 bp going to?
I can hear it echoing from the boardrooms of corporate America now: "At 1.75% there is NO way we're borrowing any money but boy oh boy, at 1.25% things are looking mighty tasty!!! Let's get out there and shovel up some of that easy money and start increasing our overcapacity so that we can make even more stuff to stack up on the shelves and hope someone will buy!"
The Fed cut rates because that's what the Fed does. The Fed meets economic weakness by easing the cost of borrowing. But here's a newsflash for the folks at the Fed: THE ECONOMY ISN'T SUFFERING BECAUSE INTEREST RATES ARE TOO HIGH. So how likely is it that lower interest rates are the ticket to recovery?
The economy is suffering because it is dealing with a glut in capacity, the unwinding of a massive financial bubble, heaps and hordes of excess still awash in the system. Five years of stock market gains (from 1995-2000) were little more than hype and speculation. Not founded in reality, not founded on real profits, not founded on improving productivity nor a better business model. Just speculation, greed, excess, and classic "bubble" economics, mixed with a dollop of bull market psychology.
It is the unwinding of THAT process which has led to this period of economic weakness. And that process is not undone by merely slashing interest rates. There is a glut in capacity. There is a glut of "stuff". Nowadays we find ourselves with 2 SUVs in the garage and 4 large screen TVs in the bathroom. How many more do we need?
Interest rates are low. Fantastic. If we needed anything more that might be a great deal. But we're awash in stuff. Detroit has been pumping out cars and practically giving them away for free. How many more cars can we buy?
Lower interest rates aren't providing much stimulus to the economy because cheap, easy money is NOT what the economy needs more of! Companies don't need to borrow more cash in order to increase production of stuff that folks aren't buying! That would be STUPID. And therefore, the Fed's main tool isn't working.
I don't care how big your hammer is nor how many times you swing it; when you need pliers, you need pliers. Nothing else will do the job. Our economy doesn't need more, cheap, easy money. It needs to work down the glut in capacity, demand has to start meeting, if not exceeding supply in order for growth to happen.
Traditionally what's helped us pop out of recession is "pent-up demand", as economists are fond of calling it. The economy slows down, folks get concerned about their future and reign in their spending habits. They spend a little less and save a bit more. Finally they reach a point where they can barely wait to start shopping again and when the urge becomes irresistible, when the price is right (following a few rate cuts), they flock to the stores once again. Voila! A recovery is in the works. (Of course the reality isn't quite that simple, but for the sake of illustration, this example will suffice.)
But this time around there is no "pent-up demand" because nobody stopped shopping. We've become a nation that can't attain any level of "pent-up demand" because we insist on instant gratification. We don't put any delays on our demands. We want it now and if we can borrow enough to get it now, we will.
The media has been entertaining us week after week with news about the "resilient consumer" (read "demand-for-instant-gratification consumer") who just can't seem to stop himself from refinancing and pumping more (borrowed) cash into the economy. The consumer has been active enough to keep the economy from slipping deep into negative territory. But not enough to create a full-blown healthy recovery.
So here we are with the Fed having slashed rates to 1.25% and nobody cares. Nobody has pent up any kind of demand and in fact, consumers are now beginning to pull back. The savings rate is on the increase while consumer confidence has plummeted to a 9-year low. Auto sales tanked last month. Even at 0%, 2 SUVs are enough for anybody. Demand for stuff is falling.
Finally consumers are questioning the spin-doctoring out of Washington and Wall Street, questioning whether a recovery is imminent, whether a bull market is on its way, whether it's wise to continue spending money they don't have. This is the point in the cycle where consumers would be jumping at low interest rates if only they had some money left to do so. But they didn't save during the recession so they have nothing with which to take advantage of this latest rate cut. There is no pent-up demand!
But the Fed wanted to have its cake and eat it too. The Fed wanted us to keep buying and spending to keep us out of a recession AND have us jump at 1.25% rates by going on another spending spree and turning things around a couple years later. It doesn't work that way. You don't get "pent-up demand" by inducing consumers to spend heartily throughout the downturn.
RECOVERIES ARE THE RESULT OF "CLEANING HOUSE", OF GETTING RID OF THE EXCESS, OF GETTING THE BOTTOM LINE IN ORDER. But the Fed's brilliant plan throughout this downturn has been to keep burying consumers deeper and deeper under mountains of debt so that Uncle Al wouldn't have to preside over a major recession and look like the inept, bumbling clown who sold out the intelligent market principles of his youth for a cushy job toeing the government line at the Fed.
The result is that the excess of the 90s hasn't been worked off and the consumer is in WORSE shape than he was when the downturn began. And the Fed wants you to believe that another 50bp rate cut is going to turn that around, that somehow we're going to defy the universal law that says "you can't get something for nothing." Somehow we're supposed to avoid ever paying the price and somehow we're going to create a healthy, powerful, sustainable recovery start with a big pile of debt, a big fat pile of nothing.
Recoveries happen when and only when a foundation for a recovery has been built. You don't create something out of nothing. And increasing debt, flooding the economy with illusory paper wealth, borrowing more and more money at lower and lower rates is a bunch of NOTHING. It takes SOMETHING to build something. Debt is NOTHING. Lower interest rates that induce people to borrow more money merely induce people to trade real wealth and value (their homes, for example) for NOTHING (debt).
I don't care how much more NOTHING the Fed can pump into the economy nor how cheap it makes that nothing. A million times NOTHING, a trillion times NOTHING, a gazillion times NOTHING is still NOTHING. NOTHING at 1.25%, NOTHING at 7.25% is still NOTHING. And you will NEVER build SOMETHING of substance on a foundation of NOTHING.
They tried it in the 90s, they tried it in the 20s and they've tried it time and time again throughout history. The inevitable result has ALWAYS been a temporary spike followed by a reversion to the mean, a return to real value. And "real value" has often been found at 90% below the peak.
Until this market and this economy revert to their real value, we will remain awash in a vast sea of NOTHING and nothing of any real substance will be created. At least nothing that smacks of genuine, sustained recovery.
But don't take my word for it. Ask Mr. Market. He isn't buying the Fed's "something for nothing" ideology either. How else to explain an S&P 500 reduced to 50% of its peak value in the wake of eleven rate cuts? If eleven didn't work, will twelve?
Hang up your hat, old man. It doesn't take ANY kind of financial "genius" to sell an addict dope (or debt, or easy money, or speculative market gains) for a decade. The real genius is in healing him after he crashes. So far Uncle Al has proven himself to be little more than a pusher for a debt-addicted nation. Good at selling the dope, not so good at healing the addict when the dope loses its luster.
The addict is laying in the gutter, exhausted and sick, paying the price for a decade-long addiction. And the pusher's response? To pump him up with more dope in hopes that he'll emerge stronger and healthier. Will it work? Perhaps. But I'm not betting on it. And it doesn't look like the market is either...
Mark M. Rostenko
Editor
The Sovereign Strategist
November 15, 2002
Mark M. Rostenko, a veteran floor trader of Chicago's commodity exchanges, is the editor of The Sovereign Strategist investment newsletter. His views have been featured in Barron's, the Wall Street Journal, the Miami Herald and many other publications. The Sovereign Strategist has achieved an amazingly accurate track record for timing the market's turning points throughout 2001 and 2002 and racking up huge profits for subscribers.
For more information or to request a free sample of The Sovereign Strategist, please visit www.sovereignstrategist.com
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