The Fed Chairman tells the President that his administration must work with Congress to cut spending or else the Fed will begin reducing its balance sheet. The President thanks him for his years of service. The Chairman, concerned with his legacy of having been too accommodative, hints to the public about tapering the Fed’s asset purchases. The dollar rallies and asset prices fall.

Perturbed, the President then publicly thanks the Fed Chairman for his years of service. The Fed Chairman escalates, publicly setting a time frame when he’ll begin tapering. The markets fall even more dramatically. The President, fearful that the Fed’s actions could destroy his legacy, quickly names a replacement for the Chairman, one that reliably plays ball. The markets rally. Through the optics of the capital markets, the President successfully perpetuates the temporary appearance of a healthy economy.

The Fed Chairman returns to the private sector with dignity, his legacy defined by providing abundant credit when necessary and then trying to set a course back to normalcy. Yet the Fed never diverges from its accommodative posture; its zero interest rate policy remains in force and quantitative easing INCREASES to record levels. The capital markets rally further as the real economy continues to contract. Washington and Wall Street are happy while real output and employment continue to fall.

A crisis “no one could have foreseen” occurs. Financial markets plunge. Banks inform the Fed their loan books are deteriorating. The Fed triples QE and yet employment rolls continue to drop. The Fed informs Congress and the President that the monetary system must be reset. The public grows angry that, just like in 2008, banks and the government gained funding through newly created money but it, the public, did not. (Civil unrest?). The State Department concurs with the Fed; foreign exporters to the U.S. no longer want US dollars in exchange and the system must be changed. At the urging of the President, Congress directs the Fed to devalue the Dollar to gold, and to reset a fixed exchange rate.

Few still dispute that the capital markets are priced at the pleasure of elected and appointed authorities. The spectacle called “economy” should continue as-is, predictably reflexive, until it is in the interest of authorities to change its rules (not as predictable yet still entirely rational and quite in the American tradition). On and on it goes until it no longer can.

Moral: When the financial markets no longer reflect the human condition, authorities must answer to true power – the marketplace.


Paul Brodsky
QB Asset Management Company, LLC, June 2013

Category: Federal Reserve, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

8 Responses to “That Pesky Marketplace – A Political Fable”

  1. winstongator says:

    What is sitting on bank balance sheets that could deteriorate? OK, still commercial real estate? Hasn’t that already been marked down considerably? You could get mark-to-market losses on treasuries held, but you would if you had a performing mortgage at 3% and rates went up to 5%.

    What would be an even bigger issue would be deposit flight. BoA (TBTF bank 10-K I picked to peruse) has such a huge retail base that it has to have a considerable percentage of its deposits as retail customers getting 0.25% or less. It would take a considerable expansion by non-TBTF, but large (> $100B in assets) banks to cut the top 4 TBTFs balance sheets in half. Is a $2T bank TBTF, but a $1T bank manageable enough? Looking at the top 50 bank holding companies:
    many of them are not retail banks…that’s not news, but they wouldn’t be able to absorb spillover from the TBTF deposit bases.

  2. denim says:

    Let me try my hand at fables. The President reads Keynes’ “The General Theory of Employment, Interest and Money.” So intrigued, he goes on to read Eccles and Hicks. Astounded that economics is so simple that anyone with an IQ above room temperature can fully grasp it, he appoints Paul Krugman as his personal White House Economics adviser and Barry Ritholtz as Treasury Secretary. The media begins to crank out stories containing economic facts rather than the economic fallacies from the hacks of the day. The voters, now knowing facts from fallacies, elects a super majority of Keynesians to Congress. And then the land of the free also becomes the land of the employed.

  3. Moopheus says:

    “The Fed Chairman tells the President that his administration must work with Congress to cut spending or else the Fed will begin reducing its balance sheet. ”

    When did this happen, or is this just fairy tale? Bernanke has in the fairly recent past gone to Congress and told them, in his polite Fed-speak way, that they should be doing more.

    It is true that the next Fed pick is fairly likely to be Janet Yellen, who has in the past been somewhat dovish on inflation (i.e., favoring more accommodation). She was the favorite to replace Bernanke the last time. On the other hand, she is also, at least judging from her public comments, one of the few people in the Fed who shows a capacity to occasionally pull their head out of their own ass and look at what’s actually happening outside.

  4. Low Budget Dave says:

    It seems the first sentence should include the phrase: “…or raise taxes…”. Although, theoretically, cutting the value of the currency in half is pretty similar to a tax on people who do not own stocks.

    This goes back to the theory that the Fed’s real purpose is to serve the stock markets and bankers. If the Fed ever does anything to benefit the American economy or currency, it is a happy accident.

    Similarly, if Wall Street switched to bitcoin tomorrow morning, the Fed would abandon the U.S. Dollar before the end of the day.

  5. Joe Friday says:

    The Fed Chairman tells the President that his administration must work with Congress to cut spending or else the Fed will begin reducing its balance sheet.

    Not only has Bernanke (as Moopheus posted) been repeatedly telling Congress “that they should be doing more”, but he has also repeatedly advised Congress NOT to “cut spending” now.

    More like a Fractured Fairy Tale.

    (Hey Rocky, watch me pull a rabbit out of my hat !)

  6. DeDude says:

    Actually there is a remarkably stong agreement between Bernanke and Obama on “cut spending later”. Both Bernanke and Obama want to stop the current sequester budget cuts and wait for the economy to get stronger. The problem is that congress is in the hands of people that refuse to let the facts get in the way of their little fairy tales of “expansionary austerity”.

  7. Mattw says:

    I like it. Good job!

    Aren’t the eagle’s wings in the process of being plucked? That would be thanks to sequestration. We may be closer to the endgame than a lot of people think.

  8. Livermore Shimervore says:

    You may think of Florida Rep. Alan Grayson as the Bronx transplant with a penchant for the ridiculous but he’s probably the single smartest elected official in that state. I can’t think of another one of the 534 members of Congress who could get the proffessor give such answers: