Federal Reserve

Between Hope and Illusion

By David Stockman  |  December 6, 2019

One day everything will be well, that is our hope;

Everything’s fine today, that is our illusion.

– Voltaire, “Poem on the Lisbon Disaster” (1756)

That’s one explosive rally on Wall Street today. The Dow Jones Industrial Average is up more than 300 points just before the noon hour – there by the grace of the Bureau of Labor Statistics…

I hyperbolize, of course, but a single month’s data from the BLS is best understood by simply removing the “L” from the acronym.

We’ll take apart the November jobs report in the December issue of The Stockman Letter. Suffice to say, it’s not as impressive as it seems.

Here’s the thing: We have a 3.5% unemployment rate – the lowest in half a century – and the stock market is near all-time highs. Yet the Federal Reserve has cut interest rates three times and has added $308 billion to its balance sheet.

Sven Henrich nailed it this morning:

Go ahead and get excited – stay excited! – about this rally. Indeed, we’ve come all the way back into the green this week, from Trade War turmoil on Monday and Tuesday to MAGA euphoria on Thursday and Friday…

Folk, we added Michael Coolbaugh to the Deep State Declassified/The Stockman Letter mix precisely because we anticipated this type of impact from the Fed’s mid-summer capitulation to the Tweeter-in-Chief and his increasingly soft aiders and abettors on Wall Street.

What Michael will do is help us identify fundamentally sound opportunities that will rise with the nonsense. More importantly, his understanding of systems and how humans use them will help us to know not only when to add to positions but when to reduce or even close them as well.

And, in January, Michael will roll out an exclusive service for investors with more active streaks; we’ll be talking a lot about Delta Profit Trader in coming weeks, so stay tuned.

In the meanwhile, let’s talk today about root causes of the coming crackup of the American experiment…

Capitalist prosperity – and constitutional governance, for that matter – are under dire existential threat. And the main cause is the Federal Reserve.

The leading edge of the threat includes anemic economic growth, metastasizing maldistribution of wealth, and an impending fiscal catastrophe.

All three stem from the destructive regime of monetary central planning that arose, congealed and became institutionalized over the last 30 years.

The moneyed classes and their champions at both ends of the Acela Corridor want easy money because it drastically and artificially inflates their financial assets. Inside-the-Beltway politicos embrace it because it deflates the carry cost of the nation’s mushrooming debts.

Indeed, the massive vested interests that feed off the Warfare State-Welfare State behemoth – beneficiaries, all, of empire and entitlement – could not survive, let alone thrive, without a red-hot printing press at the ready in the depths of the Eccles Building.

The GOP, especially its so-called conservative wing, as well as the Democratic Party, including its purportedly liberal wing, have parked their economic principles in ideological safe-deposit boxes, pretending to be oblivious to the Fed’s assault on everything they claim to hold dear.

So, what’s happened to prompt this Duopoly to bury their collective heads in the sand in the face of what is, by all historical standards, a freakish condition?

The Fed has snuffed out even a remote semblance of honest and rational interest rates, euthanizing American politicians in a manner that could be scarcely imagined only a few decades back.

I’ve witnessed 50-years of policymaking in Washington D.C., much of it up close and personal. I’m absolutely sure of one thing. Here it is…

What motivated Ronald Reagan to sign three tax increase bills from 1982 through 1984 after we way overdid the 1981 tax cuts and defense spending increases – and also what drove Bush the Elder and Bill Clinton to organize bipartisan packages of fiscal pain in the early 1990s – is the fear of soaring interest rates and the “crowding out” of private household and business borrowers.

I’m talking about the anti-deficit political force of angry constituents forced to forego a new home or capital investment.

I’m also talking about soaring interest expense on the federal debt that would snuff out spending for the domestic and foreign pork on which U.S. politicians thrive and from which the vast flows of campaign lucre arise.

What counts in this context is the real interest rate. That’s the spread between the nominal rate and the trend rate of inflation. When that spread shrinks or disappears, so does the pain factor and the crowding out that goes along with it. That’s because the “carry cost” of debt – public and private – becomes tantamount to free.

When Alan Greenspan took the helm at the Fed in August 1987, the 10-year Treasury rate was 8.66%. The inflation rate, as measured by the stable 16% trimmed-mean Consumer Price Index, was 3.82% on a year-over-year basis. So, the real rate was 484 basis points, or 4.84%.

By December 1996, when Greenspan gave his famous “irrational exuberance” performance, the 10-year rate was down to 6.43% versus a 2.87% CPI rate. That’s a 356-basis-point real rate, or 3.56%.

From there, it’s been a relentless squeeze until there was no inflation-adjusted content left in the yield on the 10-year Treasury note at all. The yield on the 10-year U.S. Treasury note is the fulcrum for the entire U.S. Treasury yield curve. It’s the benchmark for all corporate and mortgage lending. And it basically sets the weighted average carry cost of the federal debt.

Here’s the 10-year U.S. Treasury yield, the 16% trimmed-mean CPI, and the real rate at key points in recent history:

  • 92%, 2.87%, and +205 basis points by February 2001;
  • 97%. 2.22%, and +105 basis points by November 2007;
  • 89%, 2.60%, and -71 basis points by December 2011;
  • 02%, 2.20%, and -18 basis points by July 2019;
  • 69%, 2.37%, and -68 basis points by October 2019.

Note that the July 2019 situation came after the Fed’s short-lived efforts at policy “normalization.”

Here we are now, after three rate cuts and the resumption of massive buying of Treasury paper under rolling “repo” facilities and a new, $60 billion per month program.

It’s “QE4” by any other name. It’s more easy money.

That’s notwithstanding the fact that negative real rates have turned Wall Street into a gambling casino and the C-suites of Corporate America into chop shops and financial-engineering joints.

Main Street is dying.

Wall Street? Imperial Washington?

They’re thriving.

Be Independent

I’ll say it again: This is the most politicized market in history. And the Tweeter-in-Chief is still in charge. So, the situation is changing almost by the minute.

It’s “Impeachment!” in Imperial Washington and all over the Mainstream Media. It’s “Easy Money!” on Wall Street and across Bubblevision.

And it seems as if the whole world has, indeed, gone mad.

Amid this chaos, prices will continue to rise and fall, trends will continue to develop and dissipate.

Well, The Stockman Letter is made for times like these. And we’ve updated our design to help us better navigate to not only the safest harbors but also the most promising opportunities.

The stakes are as high as they can be heading into 2020. Markets appear to be straining, catching up to an economy that’s been weak and getting weaker for years.

The Donald is tied up in the day-to-day movements of the major stock indexes like no president before him. The increasingly desperate incumbent will do anything he must to hold the White House.

It’s a major tipping point. And there’s no telling what the Donald’s great disruptions could do to your wealth.

Please click here to learn more about The Stockman Letter and what comes next…

To common sense,

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David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR