It's Only The Fed, Stupid. Hike Or Not, Here's How To Profit

 | Sep 21, 2016 12:25AM ET

Democratic strategist James Carville’s “It’s the economy, stupid” catch-phrase catapulted Bill Clinton into his second term. These days economic progress and the real economy have taken a back seat to the Fed and the other central banks.

Too many market participants obsess over each inflection or raised eyebrow of a Fed, ECB, BOJ, or PBOC official. Enough already.

Here’s what I sent our clients about obsessing over the Fed—and what we are buying.

Every hiccup, eye blink or clearing of the throat from some Fed governor or their counterpart in the European Central Bank, the Bank of Japan or the People's Bank of China is carefully observed and parsed by analysts from London to Canberra to Ottawa.

And for what? World economies—and world markets—have fared no better since the advent of central bank interventions in the economy and artificial jiggering of markets than they did in the decades prior. Their latest depredation, keeping rates so low that savers are penalized and risk-taking is rewarded, may yet come a-cropper.

No, not in the short term; in the short term we can party hearty courtesy of low margin rates and cheap financing of cars, land, houses, etc. But long term? What the hell are we thinking?

$60,000,000,000,000. $60 trillion. More than the combined gross national product of the US, the EU, China and Japan. That's how much sovereign (issued by governments) debt is currently outstanding. More than 25% of this debt carries a negative interest rate. Investors are paying governments for the privilege of getting less money back in 10, 20 or 30 years —and that's less money back in today's dollars.

As central banks strive to increase inflation, they enjoy the double benefit of having investors pay them once for the privilege of holding their money, then yet again as the bankers depreciate the value of the dollars, yen, yuan or euros they have "invested" in. Nice work if you can extort it, nicer when people are dumb enough to line up for it.

By the way, the $60 trillion is but a drop in the bucket of actual "indebtedness." Yes, that figure accounts for the sovereign bonds currently outstanding. But it does not include the indebtedness of promises made. All developed nations and many developing ones have assured pensioners that they will enjoy a social security safety net when they end their working years. Still others have added the assurance that heath care, no matter the cost, will be provided to all.

Given advances in health care technology, enhanced drug therapies and significantly longer life spans, this last political promise alone could dwarf the $60 trillion in currently-outstanding sovereign debt! (Of course, it might also allow us to be more productive longer, allowing each individual to contribute to an expansion of the national wealth well into our 70s or 80s - or, worst case, it could create a generation of people barely alive or at a significantly diminished level of competence and health. We simply don't yet know).

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To cover such expenditures, governments enjoy the benefits of taxation, of course, so they can always raise taxes while steadfastly decrying the fiscal irresponsibility of previous generations of investors, taxpayers, politicians and central bankers. But the conundrum then becomes: at what point do taxes to cover yesteryear's promises become so confiscatory that they destroy entrepreneurial incentive and greater individual or national productivity?

The founder of hedge fund Elliott Management, Paul Singer, has said it most succinctly: "...the entire developed world is insolvent." He may be right.

By punishing saving and thrift, what kind of society are we creating? Economic actions have consequences that go well beyond the economic realm. The central banks of the developed world have succeeded in saving the big banks and broker-dealers, which is of course the universe in which the Fed and its clones in other nations exist and are defined by. But by encouraging corporate and financial risk-taking without consequence and punishing those on a fixed income, they are testing the limits of the law of unintended consequences.

Even if the social fabric is not irrevocably altered by this 7-year experiment, there is a more pragmatic problem: the central bankers have failed to accomplish even their single-minded goal of creating economic growth. That's what they promised if only we'd go along with their prescriptions. Look around the country, the continent, the entire developed world. Is 1% growth really better than individual workers and companies have done previously on their own with lower taxes, better education, more trade, and a whole lot less intrusive regulation? I doubt it.

Managed economies have failed miserably, from the USSR to today's Venezuela. Yet we see no recognition of this from the developed world's central bankers. Adam Smith's enlightened self-interest with appropriate and necessary regulation created the economic miracle that lifted the world from the whims of absolute monarchy, not meddling by dictators or unelected nannies with an agenda.