What's Going On?

Marvin Gaye asked this question referring to American society in the 1960s. We could ask it again in the 2010s.

This macroeconomic and monetary policy analysis by the Hussman Funds is extremely insightful. Read the full essay here. I include a few relevant excerpts below:

Several factors contribute to the broad sense that something in the economy is not right despite exuberant financial markets and a lower rate of unemployment. In our view, the primary factor is two decades of Fed-encouraged misallocation of capital to speculative uses, coupled with the crash of two bubbles (and we suspect a third on the way). This repeated misallocation of investment resources has contributed to a thinning of our capital base that would not have occurred otherwise. The Fed has repeatedly followed a policy course that sacrifices long-term growth by encouraging speculative malinvestment out of impatience for short-term gain. Sustainable repair will only emerge from undistorted, less immediate, but more efficient capital allocation.

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First, we should begin by stopping the harm. Quantitative easing will not help to reverse this process. The dogmatic pursuit of Phillips Curve effects, attempting to lower unemployment with easy money, has done little to materially change employment beyond what is likely to have occurred without such extraordinary intervention, but has contributed to speculative imbalances and an increasingly uneven income distribution. Indeed, Fed policy does violence to the economy by helping to narrow it to what complex systems theorists call a “monoculture.” Nearly every minute of business television is now dominated by the idea that the Federal Reserve is the only thing that matters. Meanwhile, by pursuing a policy that distinctly benefits those enterprises whose primary cost is interest itself, the Fed’s policies have preserved and enhanced too-big-to-fail banks, financial engineering, and speculative international capital flows at the expense of local lending, small and medium-size banks and enterprises, and ultimately, economic diversity.

The always observant Charles Hugh Smith puts it this way: “Diversity and adaptability go together; each is a feature of the other. The Federal Reserve has created an unstable monoculture of an economy. What should have triggered a ‘die off’ of one predatory species – the ‘too big to fail’ mortgage/commercial banks and the Wall Street investment banks – was redistributed to all other participants. In insulating participants from risk, fact-finding, and volatility, you make price discovery and thus stability impossible.”

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The Federal Reserve’s prevailing view of the world seems to be that a) QE lowers interest rates, b) lower interest rates stimulate jobs and economic activity, c) the only risk from QE will be at the point when unemployment is low enough to trigger inflation, and d) the Fed can safely encourage years of yield-seeking speculation – of the same sort that produced the worst economic collapse since the Depression – on the belief that this time is different. From the foregoing discussion, it should be clear that this chain of cause and effect is a very mixed bag of fact and fiction.

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The economy is starting to take on features of a winner-take-all monoculture that encourages and subsidizes too-big-to-fail banks and large-scale financial speculation at the expense of productive real investment and small-to-medium size enterprises. These are outcomes that our policy makers at the Fed have single-handedly chosen for us in the well-meaning belief that the economy is helped by extraordinary financial distortions.