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Cuckoo’s Nest Minutes – FOMC Delusions

Translation of the FOMC meeting minutes is a regular feature of the Wall Street Examiner Professional Edition Fed Report. However, the August meeting was so astounding in its implications that I wanted to share my interpretation of the minutes on wider basis for the purpose of inviting discussion. Please feel free to add your comments in the reader comment section at the end of the post.

At last month’s FOMC meeting, the Fed finally recognized the fact that artificially suppressing interest rates is increasing the rate at which mortgages are being paid off.

The Manager also noted the staff’s projection that, if mortgage rates were to remain near their levels at the time of the meeting, repayments of principal on the agency MBS held in the SOMA likely would reduce the face value of those holdings by roughly $340 billion from August 2010 through the end of 2011. The level of repayments would be expected to increase further if mortgage rates were to decline from those levels. In addition, about $55 billion of agency debt held in the SOMA portfolio would mature over the same time frame.

In the staff review of the economy, they also recognized that a declining unemployment rate is a bogus indication because in reality, fewer people are working.

The unemployment rate moved down in June from its level earlier in the year, and was unchanged in July, as declining civilian employment was accompanied by decreases in labor force participation. Initial claims for unemployment insurance remained at an elevated level over the intermeeting period.

Their inability to step outside their ivory tower is one reason they have no clue what’s going on in real time. They’re just discovering this?

Revised data indicated that consumer spending fell more sharply in 2008 and in the first half of 2009, and subsequently recovered more slowly, than previously estimated.

In the staff review of the financial markets, they finally appear to recognize that low interest rates are suppressing money growth.

M2 was little changed in July after expanding slightly in the second quarter. Its subdued growth in recent months likely reflected a continued unwinding of earlier safe-haven flows as well as the very low rates of return on some components of M2, particularly small time deposits and retail money market mutual funds.

In the staff economic outlook, they lowered their forecast, but continued to expect growth (There will be growth in the spring- Chance the gardener). That was based on a bunch of unsupportable assumptions and the misconception that low interest rates support growth. In short it’s the usual mainstream economic gibberish that results in their economic growth forecasts always being wrong all of the time.

…the staff lowered its projection for the increase in real economic activity during the second half of 2010 but continued to anticipate a moderate strengthening of the expansion in 2011. The softer tone of incoming economic data suggested that the pace of the expansion would be slower over the near term than previously projected. Financial conditions, however, became somewhat more supportive of economic growth. Interest rates on Treasury securities, corporate bonds, and mortgages moved down further over the intermeeting period; the dollar reversed its April to June appreciation; and equity prices edged higher. Over the medium term, the recovery in economic activity was expected to receive support from accommodative monetary policy, further improvement in financial conditions, and greater household and business confidence. Over the forecast period, the increase in real GDP was projected to be sufficient to slowly reduce economic slack, although resource slack was still anticipated to remain quite elevated at the end of 2011.

Committee members parroted the staff views concluding:

…while they saw growth as likely to be more modest in the near term, participants continued to anticipate that growth would pick up in 2011[Chance the gardener again].

Stupid is as stupid does. To the FOMC I say, “You still fail to see the obvious fact that zero interest rates force those with cash to pay off debt and at the same time REDUCE CONSUMPTION, YOU MORONS!”

Revised national income and product account data showed that the contraction in aggregate output during the recent recession had been larger than previously reported. In particular, consumer spending had contracted more over the course of 2008 and the first half of 2009, and recovered less rapidly, than previously estimated, even as households’ after-tax incomes had increased more than shown by the earlier data. In combination, these revisions indicated that the personal saving rate had been higher and had risen somewhat more during the past three years than previously thought. Participants recognized that the implications of these new data for the outlook were unclear. On the one hand, the revised data might indicate that households have made greater progress in repairing their balance sheets than had been realized, potentially allowing stronger growth in consumer spending as the recovery proceeds. On the other hand, the revised data might signify that households are seeking to raise their net worth more substantially than previously understood, or to build greater precautionary balances in what they perceive to be a more uncertain economic environment, with the result that growth in consumer spending could remain restrained for some time.

The two ideas are not mutually exclusive. Households ARE improving their balance sheets BECAUSE they are SPENDING LESS AND RAISING PRECAUTIONARY BALANCES. On the other hand, many have no balances because they were already forced to spend all of their principal, thanks to the fact that they could not earn a return on that principal. If the Fed would allow interest rates to rise to a reasonable level, people who do have cash will start to spend. They will continue to pay down debt and hold larger cash balances as long as low risk investment rates are near zero.

Their cluelessness apparently knows no bounds. In looking at the phony market distortions created by the homebuyers’ tax credit, they thought they were looking at something real.

Many participants noted that the protracted downturn in house prices and in residential investment seemed to have ended, although ups and downs in housing starts and home sales associated with the temporary tax credit for homebuyers made it difficult to be certain. A few commented that home sales and prices appeared to be edging up in their Districts. While recognizing that the housing sector likely had bottomed out, participants observed that large inventories of vacant and unsold homes, along with continuing foreclosures that would increase the number of houses for sale, likely would continue to damp residential construction, indicating that a sustained upturn from very low levels was not imminent.

They noted that decreasing stimulus would impact growth, but not that the “growth” was potentially entirely due to the stimulus and that therefore it would go negative as stimulus effects subsided.

…growth in Europe and Asia apparently remained solid, boosting U.S. exports. Nonetheless, a continuation of strong foreign growth would require a pickup in private demand abroad to offset a decline in policy stimulus and a smaller boost from inventory investment. Several participants noted that the same shift in the sources of demand would need to take place in the United States: Waning fiscal stimulus on the part of the federal government and continuing retrenchment in spending by state and local governments would weigh on the economic recovery, and recent data raised questions as to whether private demand would strengthen enough to increase resource utilization.

These people have NEVER had any ability to guess where employment levels might be heading, as I demonstrated in my previous review of their forecasts dating back to 2007. They did however mention the fact of shrinking overall employment, which is something that is NEVER mentioned by mainstream media pundits.

The incoming data on the labor market were weaker than meeting participants had anticipated. Private-sector payrolls grew sluggishly in recent months. The unemployment rate declined a bit, but that reflected a decrease in labor force participation rather than an increase in employment… [P]articipants… noted that employment was lower than a year earlier and that job openings were only slightly above their lowest level in 10 years, indicating that few firms saw a need to add employees.

After considering all the negative information they then came to the unsupported and unsupportable conclusion that the economy would grow and strengthen in 2011. They admitted that they were surprised by the weakening of the data, then applied magical thinking to conclude that by next year, all would be well again.  Clueless and delusional, or simply lying? You be the judge.

Weighing the available information, participants again expected the recovery to continue and to gather strength in 2011. Nonetheless, most saw the incoming data as indicating that the economy was operating farther below its potential than they had thought, that the pace of recovery had slowed in recent months, and that growth would be more modest during the second half of 2010 than they had anticipated at the time of the Committee’s June meeting. Some policymakers whose forecasts for growth had been in the low end of the range of participants’ earlier projections viewed the recent data as consistent with their earlier forecasts for a weak recovery. A few participants, observing that month-to-month data releases are noisy and subject to revision, did not see the recent data as clearly indicating a change in the outlook. [If that ain’t delusional, what is?]Many policymakers judged that downside risks to the U.S. recovery had become somewhat larger; a few saw the incoming data as suggesting a greater risk that private demand for goods and services might not grow enough to offset waning fiscal stimulus and a smaller impetus from inventory restocking. In contrast, most saw a reduced risk of financial turmoil in Europe and attendant spillovers to U.S. financial markets.

Their track record on inflation is good. It’s the only thing they seem to have a handle on. But here’s the problem. They refuse to recognize that their zero interest rate policy is deflationary rather than inflationary. Also they continue to focus on “long run inflation expectations” as somehow being important. In other words, it’s what people think inflation or deflation will be in the future, rather than what it actually is that matters. To me, being the simpleton that I am, that’s just plain C-R-A-Z-Y!

Policymakers generally saw the inflation outlook as little changed. They observed that a range of measures continued to indicate subdued underlying inflation and that growth in wages and compensation remained quite moderate. Many said they expected underlying inflation to stay, for some time, below levels they judged most consistent with the dual mandate to promote maximum employment and price stability. Participants viewed the risk of deflation as quite small, but a number judged that the risk of further disinflation had increased somewhat despite the stability of longer-run inflation expectations. One noted that survey measures of longer-run inflation expectations had remained positive in Japan throughout that country’s bout of deflation. A few saw the continuation of exceptionally accommodative monetary policy in the United States as posing some upside risk to inflation expectations and actual inflation in the medium run.

Finally, the committee discussed what to do about all this. This condition, from the people who brought you the housing bubble that they never saw, was notable.

While no member saw an appreciable risk of deflation, some judged that the risk of further near-term disinflation had increased somewhat.

Then they discussed what to do about their suddenly shrinking portfolio, which they hadn’t foreseen, in light of the weakening economy that they also hadn’t foreseen. I admit that they thought of something that I missed which is that mortgage refis would reduce their portfolio because the new mortgages would be outside their MBS pool. That’s obvious. I was only thinking about the incentive to pay off mortgages completely. That’s something that they are not thinking about at all, but it is happening. Fannie Mae’s total book is down by $120 billion in the past year. Freddie’s is down by just $20 billion. Both portfolios shrank in July. But the Fed only recognized that:

The decline in mortgage rates since spring was generating increased mortgage refinancing activity that would accelerate repayments of principal on MBS held in the SOMA. The decline in mortgage rates since spring was generating increased mortgage refinancing activity that would accelerate repayments of principal on MBS held in the SOMA. Private investors would have to hold more longer-term securities as the Federal Reserve’s holdings ran off, making longer-term interest rates somewhat higher than they would be otherwise. Most members thought that the resulting tightening of financial conditions would be inappropriate, given the economic outlook.

They assumed that this would cause mortgage rates to rise, failing to recognize that mortgage rates may be suppressed by other factors, such as the fact that loan demand is very weak when housing prices are falling and you’re worried about your job; and the fact that the reduced supply of mortgage paper would result in higher prices and lower yields, not the other way around. They just assumed that financial conditions would tighten, when in fact the evidence of the past several months was that the faster the supply of mortgage paper shrank, the lower rates went. There was no tightening of financial conditions. In fact, just the opposite occurred. What made them expect that to change, to the point that the step they took would only exacerbate the trend (buying Treasuries)?

So they argued about what to do and how to do it, as well as the risks that their actions might entail, never recognizing the risk that their action might well exacerbate the current trend of deflationary debt collapse. You can’t recognize what you refuse to see. They argued about everything EXCEPT the one thing that was actually happening, a debt collapse exacerbated by low investment returns.

Most members thought that the resulting tightening of financial conditions would be inappropriate, given the economic outlook. However, members noted that the magnitude of the tightening was uncertain, and a few thought that the economic effects of reinvesting principal from agency debt and MBS likely would be quite small. Most members judged, in light of current conditions in the MBS market and the Committee’s desire to normalize the composition of the Federal Reserve’s portfolio, that it would be better to reinvest in longer-term Treasury securities than in MBS. While reinvesting in Treasury securities was seen as preferable given current market conditions, reinvesting in MBS might become desirable if conditions were to change. A few members worried that reinvesting principal from agency debt and MBS in Treasury securities could send an inappropriate signal to investors about the Committee’s readiness to resume large-scale asset purchases. Another member argued that reinvesting repayments of principal from agency debt and MBS, thereby postponing a reduction in the size of the Federal Reserve’s balance sheet, was likely to complicate the eventual exit from the period of exceptionally accommodative monetary policy and could have adverse macroeconomic consequences in future years.

So they all decided to do exactly that which would make the collapse accelerate, buy more Treasury paper.

All but one member concluded that it would be appropriate to begin reinvesting principal received from agency debt and MBS held in the SOMA by purchasing longer-term Treasury securities in order to keep constant the face value of securities held in the SOMA and thus avoid the upward pressure on longer-term interest rates that might result if those holdings were allowed to decline.

The Fed has spent the past 20 years ruining the US economy. With these delusional psychotics in charge, there is no hope of any recovery… ever.

…because like all those who are victims of psychosis, they actually believe their own delusions. To them, they are real. For the rest of us, the results of their deluded policies are, unfortunately, all too real.

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Think the Fed understands the economy? Read this.

The Fed- Clueless, Delusional, or Both?

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