An All Too Visible Hand

When Wilson signed the Federal Reserve Act into law in 1913, the very idea of a macroeconomy—something to be measured and managed—was yet to be invented

By James Grant

An eagle, designed by Sidney Waugh, sits above the main portico of the Federal Reserve Building in Washington, D.C.      An eagle, designed by Sidney Waugh, sits above the main portico of the Federal Reserve Building in Washington, D.C. Photo: Bloomberg

The Federal Reserve is America’s problem and the world’s obsession. When will Janet Yellen choose to lift the federal-funds rate from its longtime resting place of zero, thereby upending or not upending (it depends on whom you ask) individuals and markets in all four corners of the earth? Her subjects await a sign. While tapping their feet, they may ponder how things ever came to this pass.

How, indeed, did such all-powerful body come into existence in the first place—and why?

Roger Lowenstein’s “America’s Bank,” which chronicles the passage of the 1913 Federal Reserve Act, is victor’s history. Its worldview is that of today’s central bankers, the bailers-out of markets, suppressors of interest rates and practitioners of money conjuring. In Mr. Lowenstein’s telling, what preceded the coming of the Federal Reserve was a financial and monetary dark age. What followed was the truth and the light.

It sticks in the craw of good Democrats that, in 1832, their own Andrew Jackson vetoed the rechartering of the Second Bank of the United States, the predecessor of the Federal Reserve. Just as galling is the fact that Old Hickory’s veto message is today counted as one of America’s great state papers. In it, Jackson denies to Congress the power to delegate its constitutionally given duty to “coin money and regulate the value thereof.” To do so, Jackson affirmed, would render the Constitution a “dead letter.”

Mr. Lowenstein contends that, in the creation of the Federal Reserve 80 years later, Congress and the people commendably put that hard-money Jacksonian claptrap behind them.

Mandarin rule is the way forward in monetary policy, he suggests—the Ph.D. standard, as one might call it, under which former tenured economics faculty exercise vast discretionary power over the value of money and the course of interest rates, financial markets and business activity. Give Mr. Lowenstein this much: As the world awaits the raising of the Fed’s minuscule interest rate, the questions he provokes have never been timelier. Not for the first time the thoughtful citizen must wonder: What’s money and who says so?

When Woodrow Wilson signed the Federal Reserve Act into law in 1913, the dollar was defined as a weight of gold. You could exchange the paper for the metal, and vice versa, at a fixed and statutory rate. The stockholders of nationally chartered banks were responsible for the solvency of the institutions in which they owned a fractional interest. The average level of prices could fall, as it had done in the final decades of the 19th century, or rise, as it had begun to do in the early 20th, without inciting countermeasures to arrest the change and return the price level to some supposed desirable average. The very idea of a macroeconomy—something to be measured and managed—was uninvented. Who or what was in charge of American finance?

Principally, Adam Smith’s invisible hand.

How well could such a primitive system have possibly functioned? In “The New York Money Market and the Finance of Trade, 1900-1913,” a scholarly study published in 1969, the British economist C.A.E. Goodhart concluded thus: “On the basis of its record, the financial system as constituted in the years 1900-1913 must be considered to have been successful to an extent rarely equalled in the United States.”

The belle epoque was not to be confused with paradise, of course. The Panic of 1907 was a national embarrassment. There were too many small banks for which no real diversification, of either assets or liabilities, was possible. The Treasury Department was wont to throw its considerable resources into the money market to effect an artificial reduction in interest rates—in this manner substituting a very visible hand for the other kind.

Mr. Lowenstein has written long and well on contemporary financial topics in such books as “When Genius Failed” (2000) and “While America Aged” (2008). Here he seems to forget that the past is a foreign country. “Throughout the latter half of the nineteenth century and into the early twentieth,” he contends, “the United States—alone among the industrial powers—suffered a continual spate of financial panics, bank runs, money shortages and, indeed, full-blown depressions.”

If this were even half correct, American history would have taken a hard left turn. For instance, William Jennings Bryan, arch-inflationist of the Populist Era, would not have lost the presidency on three occasions. Had he beaten William McKinley in 1896, he would very likely have signed a silver-standard act into law, sparking inflation by cheapening the currency. As it was, President McKinley signed the Gold Standard Act of 1900, which wrote the gold dollar into the statute books.

The doctrine that interest rates are the Federal Reserve’s to manage has come to be regarded, at least by the mandarins, as settled science. It was not so when the heroes of Mr. Lowenstein’s story were conspiring to create a new central bank. Abram Piatt Andrew Jr. took to the scholarly journals to denounce the government’s attempts to pin down money-market interest rates.

Indiana-born, Andrew came East to study, taught economics at Harvard and lent his talents to the National Monetary Commission in 1909 and 1910—the group that conducted the field work to prepare for the grand banking reform. Somewhere along the line, he conceived the idea that the money market should be free of federal manipulation. As prices had been rising—a gentle inflation had begun just before the turn of the 20th century—interest rates should have followed prices higher. That they did not was the complaint that Andrew laid at the doorstep of the government.

Andrew contended that the Treasury Department—under Lyman J. Gage, who served from 1897 to 1902, and his successor, Leslie M. Shaw, who resigned in 1907—“succeeded in keeping the money rate of interest below the rate which would have been ‘normal’ or ‘natural.’ . . .

They had kept alive a continuously excessive demand for credit by making it available at less than the normal cost. They had sown the wind and their successor was to reap the whirlwind.”

It is an indictment that comes ready-written against the Federal Reserve’s policy today.

Interest rates are prices. Far better that they be discovered in the marketplace than administered from on high. One has to wonder what Andrew would say if he were spirited back to earth to read a random edition of this newspaper in the seventh year of the Fed’s attempt to create prosperity through the technique of zero-percent interest rates. He might want a quiet word with Ms. Yellen.

Andrew is not the only vivid personality in this tale of unintended consequences. Mr. Lowenstein entertainingly limns a gallery of them: Paul Warburg, a German-banker immigrant eager to import European ideas into his adopted country; Carter Glass, an irritable Virginia newspaperman turned congressman (later senator) and currency reformer; Nelson Aldrich, a suspiciously affluent Rhode Island senator and central-bank exponent; Robert Owen, a former Indian agent from the Oklahoma Territory who pushed the Federal Reserve Act through the Senate; William Gibbs McAdoo Jr., the Treasury secretary who married the boss’s daughter; that boss himself, Woodrow Wilson; and Frank Vanderlip, president of what today is Citigroup. C 2.15 % 
Vanderlip, not alone among his fellow agitators for a central bank, was keen on the gold standard and “fervent,” as Mr. Lowenstein puts it, in his “denunciations of government control.” Here is a fine piece of irony. Government control is exactly what the authors of the Federal Reserve Act unintentionally achieved, though Andrew, at least, might have anticipated this public-policy reversal. He noticed that, under Leslie Shaw’s meddling stewardship in the early years of the 20th century, the Treasury had shifted government deposits to private institutions in times of crisis. “Outside relief in business, like outdoor charity,” as Mr. Lowenstein quotes him saying, “is apt to diminish the incentives to providence, and to slacken the forces of self-help.”

Centralized government control arrived in force with the Banking Act of 1935. It established the centralization of monetary power within the Federal Reserve Board in Washington, and it repealed the so-called double-liability law on bank stocks: No more would the holders of common stocks in failed banks be assessed to help defray the debts of the institutions in which they had invested. Anyway, there would be precious few failures to deal with, proponents of the new thinking contended. Knowing that the Federal Deposit Insurance Corp. stood behind their money, depositors would give up running; they would rather walk to the bank.

The new doctrines repulsed H. Parker Willis, a key player during the organization of the Fed and later a professor of banking at Columbia University. “It is far better, both for the depositor and the banker,” said Willis of the FDIC, “that the actual net irreducible losses growing out of bank failure should fall where they belong. The universal experience with this kind of insurance—if it may be called—has pointed to the danger of increasing losses as the result of bad banking management induced by belief in deposit guarantee.”

Willis didn’t imagine the half of it. On top of deposit insurance evolved the notion that some banks—Citi, for instance—were too big to fail. They must be nurtured through subsidy and bank-friendly monetary policy: low money-market interest rates, for example. It happened that the Citigroup that evolved from Vanderlip’s National City Bank became a ward of the state in 2008. The massive federal bailout of Citi exacted many costs, including a level of regulatory micromanagement that Vanderlip could not have begun to conceive.

J.P. Morgan Chase, JPM 1.08 % which did not fail in 2008, recently went public to describe the intensity of the federal oversight it labors under. More than 950 employees, it revealed, are dedicated to complying with 750 requirements laid down by 21 government entities to achieve and maintain capital adequacy. The Fed itself is high among those demanding overseers. The workers shuffle 20,000 pages of documentation and manipulate 225 econometric models.

The rage to micromanage spans the world. “It can’t be,” the head of Sweden’s Nordea Bank NRBAY 2.47 % was quoted forlornly saying last year in the Financial Times, “that the only purpose of banking is to stop banks from going bankrupt.” Oh, yes it can.

One thinks back to the supposed financial dark ages when, in 1842, New Orleans bankers, setting down a kind of operational manifesto, succeeded in committing the essentials of safe and sound banking practice to one side of one page. They prospered by simple maxims—e.g., do what you will with your own capital but do not abuse the depositor’s funds—well after the Civil War. Some may protest that banking has become more complex since those days. The boggling, 23,000-page length of the Dodd Frank Wall Street Reform and Consumer Protection Act of 2010 (complete with supporting rules) would suggest that it has become 23,000 times more complex. I doubt that.

The legislation to which President Wilson affixed his signature in 1913—Mr. Lowenstein observantly notes that he signed with gold pens—included no intimation of the revolutionary techniques of monetary control that would come into being after 2008: zero-percent interest rates, “quantitative easing,” and central-bank-sponsored bull markets in stocks and real estate, among others.

The great value of “America’s Bank” is the comparison it invites between what lawmakers intend and what they achieve. The act’s preamble described a modest effort “to provide for the establishment of the Federal Reserve banks, to furnish an elastic currency, to afford means of rediscounting commercial paper and to establish a more effective supervision of banking in the United States and for other purposes.” “And for other purposes”—our ancestors should have known.

Fed Anxious To Raise Rates

For the past 7 years, Fed policies have been on “emergency” conditions.
The economy moved off that condition years ago, but they’ve kept these policies in place.
Why? It’s due to pressure from Wall Street and the financial industry since the policies have led to stock market gains and easy terms to finance stock buybacks and M&A.
The Fed this day changed its language, dropping worries about global economic conditions that may negatively affect the U.S. economy. That is considered “hawkish,” meaning now they’re free to raise.
10-28-2015 6-48-32 PM JY2
For the past 7 years, Fed policies have been on "emergency" conditions.
The economy moved off that condition years ago, but they've kept these policies in place.
Why? It's due to pressure from Wall Street and the financial industry since the policies have led to stock market gains and easy terms to finance stock buybacks and M&A activity.
The Fed this day changed its language, dropping worries about global economic conditions that may negatively affect the U.S. economy. That is considered "hawkish," meaning now they're free to raise interest rates sooner. But Wall Street wasn't buying it, as stocks rallied post the announcement.
Nevertheless, after all this time, the Fed is still finding it difficult to normalize monetary policies. Bulls love and feast on their indecision.
U.S. stocks rallied sharply after an early bout ("the first move's the wrong move") of selling.
On the other hand, overseas markets, especially emerging markets, still experienced selling, as did currency markets and precious metals due to a rise in the dollar. And as stocks rallied, bond markets witnessed modest selling.
Market sectors moving higher included: S&P (NYSEARCA:SPY), Dow (NYSEARCA:DIA), Small-Caps (NYSEARCA:IWM), Mid-Caps (NYSEARCA:MDY), Financials (NYSEARCA:XLF), Energy (NYSEARCA:XLE), Materials (NYSEARCA:XLB), Retail (NYSEARCA:XRT), Semiconductors (NYSEARCA:SMH), Europe (NYSEARCA:VGK), Hedged Europe (NYSEARCA:HEDJ), EAFE (NYSEARCA:EFA), Japan (NYSEARCA:EWJ), Hedged Japan (NYSEARCA:DXJ), Russia (NYSEARCA:RSX), Canada (NYSEARCA:EWC), Crude Oil (NYSEARCA:USO) and so forth.
Market sectors moving lower included: Transports (NYSEARCA:IYT), Utilities (NYSEARCA:XLU), Consumer Staples (NYSEARCA:XLP), REITs (NYSEARCA:IYR), Emerging Markets (NYSEARCA:EEM), China (NYSEARCA:FXI), Shanghai (NYSEARCA:ASHR), Brazil (NYSEARCA:EWZ), India (NYSEARCA:EPI), South Korea (NYSEARCA:EWY), Taiwan (NYSEARCA:EWT), Australia (NYSEARCA:EWA), Asia ex-Japan (NASDAQ:AAXJ), Philippines (NYSEARCA:EPHE), Thailand (NYSEARCA:THD), Indonesia (NYSEARCA:IDX), Singapore (NYSEARCA:EWS), Gold (NYSEARCA:GLD), Gold Stocks (NYSEARCA:GDX) and others.
The top ETF daily market movers by percentage change in volume whether rising or falling is available daily.
Volume improved given the Fed announcement, and breadth per the WSJ was positive.
10-28-2015 7-27-00 PM diary
  • The NYMO is a market breadth indicator that is based on the difference between the number of advancing and declining issues on the NYSE. When readings are +60/-60, markets are extended short term.
    The McClellan Summation Index is a long-term version of the McClellan Oscillator. It is a market breadth indicator, and interpretation is similar to that of the McClellan Oscillator, except that it is more suited to major trends. I believe readings of +1000/-1000 reveal markets as much extended.

    The VIX is a widely used measure of market risk and is often referred to as the "investor fear gauge." Our own interpretation is highlighted in the chart above. The VIX measures the level of put option activity over a 30-day period. Greater buying of put options (protection) causes the index to rise.

Closing Comments

A lot of the old rules we've followed as investors have fallen away given the interference and manipulation of markets by Fed policies.

Even they have a sense "emergency" policies developed seven years ago have long overstayed. Wall Street positive stock market results and so forth have pressured them to maintain these policies.

The Fed does march to Wall Street's tune after all.

GDP Data is on tap for Thursday and it too has fallen to government manipulation. And so it goes.
Let's see what happens.

Schadenfreude - How the US Is Helping China Create a New Financial Order

by Jeff Thomas

Here we have an image of a Chinese banknote, featuring Chairman Mao, followed by a seemingly incongruous German word - schadenfreude. Is there an error here?

Happily, no. We’ll begin with the word, schadenfreude, which means “harm-joy.” It’s used to express an occurrence that’s destructive, yet brings about happiness.

This would seem to be a conflict in terms, but, looked at a bit more deeply, it could be said that the killing of an enemy may mean that peace will soon prevail - and so the event brings happiness. Or, another analogy: the bulldozing of an old structure may mean that a new one - a better one - will soon be under construction.

And that’s the case here. The world’s most powerful (and most oppressive) political/economic power structure has begun to go under the bulldozer. Its replacement will hopefully be a better one.

The Brussels SWIFT system is currently the largest economic settlement system in the world.

Almost all financial transfers are made possible through this system. As such, those who control SWIFT have the power to threaten financial institutions and sovereign nations that, if they don’t do as they’re told, can be denied access to the system.

The controllers of SWIFT have been far from fair in making these judgements. Much of their agenda has been provided by the Organisation for Economic Co-operation and Development (OECD), a cabal made up of many of the world’s most powerful nations, but primarily Europe and the US. The US is the heavy here and they’ve used their power to create FATCA, a means of applying draconian economic pressures on their own citizens. In doing so, they’ve also succeeded in creating a global shakedown racket aimed at financial institutions. If a bank anywhere in the world is found to have a US citizen as a client and the bank fails to regulate that client sufficiently, the bank itself is “held up” - the US imposes a massive fine on the bank.

Editor’s Note: If you have never heard of FATCA before I can’t blame you. That so few people understand what it is, is perhaps not surprising. Often, otherwise offensive government actions and institutions are given dull and opaque names to obfuscate their true purpose. Obama signed FATCA into law in 2011. To understand what this odious law that is all about, see here.

Not surprisingly, the banks of the world (other than the central banks, which are not targeted by FATCA) live in dreaded fear of making the slightest error in trying to please the US government. They’ve been learning that although FATCA claims to be aimed primarily at its non-compliant citizens, there have been other targets. The US government has used the opportunity to go after the bigger fish - the banks themselves.

Again, the reason for this success in creating this shakedown racket has hinged on US control over the levers of the international financial system - the fear in financial institutions that the US could simply end the banks’ ability to do business if they don’t pay the outrageous fines.

But this scam only works as long as there is no competitor to the US system. Should there be a free market in the transfer of money - should there be even one competitor in the world - one that does not impose economic mafia-tactics, the potency of the US’ threat would collapse. At that point, business and sovereign nations may cease their use of SWIFT and move over to the new competitor.

Cross-border Interbank Payment System (CIPS)

And here is where schadenfreude steps in. China has had their own independent settlement system in the works for some time and it has now been introduced.

But, before opening up a bottle of bubbly, it would be wise to acknowledge that full implementation may take a few years. It will begin as a means by which to settle oil and gas accounts in keeping with agreements that already exist between China and other nations. As CIPS gains strength, its use will spread outward. This is a virtual certainty, as the more it spreads, the greater the Chinese influence over such entities as the IMF.

And CIPS will not simply replace SWIFT. What will occur will be that it will be presented as a system that can work alongside SWIFT and interface with it. (e.g., if Germany wishes to have enough natural gas to heat its houses in the winter, Russia would require that the payments for Russian gas be settled through the use of CIPS.)

The final holdout will be the US, as it has so much more to lose. However, once isolated as the only country that avoids the use of CIPS, demands from China that interfacing take place will force the US to either get on board, or be unable to acquire foreign (particularly Chinese) goods.

At some point along the way, increasing numbers of the world’s banks will cease to query account applicants as to whether they hold a US passport. They will only wish to know if the applicant has access to CIPS. Over time, the FATCA shakedown will die away, as its driving force - intimidation of the world’s banks - will no longer have teeth.

Other Developments

In parallel to the creation of CIPS, China has created the Asian Infrastructure Investment Bank (AIIB). This, together with agreements with Russia and other nations (including some EU nations), has made possible the sale of oil to be settled in yuan.

The yuan has also overtaken the yen as the fourth most-used currency for international settlement. Next target: the pound, then the euro, then the US dollar.

How Will It All Shake Out?

There are two general schools of thought amongst noted contrarians and libertarians regarding China’s overriding objectives. One school has it that China is very much a part of the One World Government philosophy and their primary goal is to acquire a more powerful seat at the IMF. Having done so, they will settle in and be content to be one of the leading jurisdictions that run the world collectively.

The other school suggests that China means to become the most powerful nation in the world - to replace the US in every way as the world’s dominant nation.

My own appraisal is a combination of the two. China’s behaviour - not only their public stance, but their massive economic infrastructural development efforts indicate to me that they intend to go full-bore with their new economic infrastructure, giving them powers that rival and even overtake the EU and US. At that point, they will be unconcerned as to whether they will be welcomed into the “club” that is presently dominated by the EU and US. They will be an unstoppable freight train passing through town. The western world can either get on board, or fall by the wayside. The Chinese will prefer the former, as it would be more profitable and would avoid conflicts (both military and economic), but they will not be deterred.

At this moment in time, we’re observing a part of that effort. The old structure is being slowly bulldozed and a new structure is underway. It’s very likely that, in order to assure its success, it will be a better one - one which offers its users greater freedom. We can be certain that, like all governmental constructs, it will eventually become corrupted and be just as oppressive as the one it hopes to replace. However, in its early years (and hopefully beyond that) the people of the world will enjoy a period of increased economic freedom.

Some time ago, when I first predicted that China would create such a system, it seemed almost a fairy tale - a highly unlikely development. Yet, China has gotten there even faster than I’d expected. Let’s hope that the day when its benefits trickle down to the street level, worldwide, will also arrive more quickly than I had expected.

The Federal Reserve Can't Solve Low Rates

- Bond yields are terrible and the weak interest rate environment is hammering retirees.
- Inflation is nonexistent for most of the economy, it is just the retirees getting screwed.
- Despite all the posturing by the Federal Reserve, the market is starting to recognize their futility.
The problem with raising rates is tied to the flow of jobs between countries.
- The only hope for raising rates is an international agreement between central banks to raise rates in unison.
Are you wishing you could buy a high quality bond and get a respectable yield from the interest income rather than betting on the direction interest rates will move in the future? I know the feeling.

My portfolio includes two mREITs and precisely zero direct bond positions. The problem is that my primary reason for buying bonds would not be the interest income; it would be a play on interest rates moving even lower. I believe a very solid investment thesis can be written for rates moving even lower, but I don't like buying into a bond position to make short term bets on price movements. It goes against my investment philosophy of establishing long term positions in quality assets.

Rates Suck, No Improvement on the Horizon

I feel for the millions of retirees that would love to have a substantial bond position to establish a reliable level of income for their portfolio that was contractually obligated rather than relying almost entirely on dividend income as the driver of the portfolio's income. The situation they are facing stinks, but I don't foresee interest rates moving materially higher on a permanent basis in the next decade. I'll grant the Federal Reserve may offer some really great posturing that could drive up yields and down prices, but I'd see that as a bond buying opportunity since I don't think "high" rates will last. To be fair, the rates we are likely to see would be better described as "less anemic" than high.

The Federal Reserve Can't Do It

When it comes down to it, I simply don't believe the Federal Reserve can create the influence on interest rates that they want to create. Further, I believe that their posturing is damaging their credibility with the market. While the board continues to blather about the importance of raising rates, the market is placing their own bets and clearly the Federal Reserve has about as much credibility as a five year old with chocolate smeared on his face. Sure, it was the dog that got into the cookies…

The best guesses currently available for predicting the movements of the Federal Reserve come through the form of the "Fed Fund Futures". The following chart from demonstrates the markets belief in the Federal Reserve jacking up rates at the next meeting:

(click to enlarge)

Note the red arrow indicating a 6% chance of an increase in rates. I'd say that's about the same level of credibility I'd give that kid with chocolate on his face.

The Problem

It isn't that Federal Reserve does not want to raise rates; it is that the international markets are simply not going along with that script. The Federal Reserve has a dual mandate for price stability and full employment. The goal for inflation has generally been 2% per year and full employment is sometimes assumed at 5% unemployment. We have been seeing inflation, but it has not been inflation across the entire economy. I think retirees have been disproportionately impacted by the inflation as a function of the premiums they must pay. Since increasing costs have not been evident across the entire economy, it is difficult to believe that the Federal Reserve will suddenly declare that the 2% goal is achieved.

The unemployment picture is even worse. I believe full employment is around 3% unemployment rather than 5%, but I don't think the Federal Reserve wants to buy into that theory. When they apply the Taylor Rule to policy decisions, they may generate a higher expected fair rate than I would generate because they have a different baseline assumption about the definition of full employment.

Even if the Federal Reserve can force short term rates higher, the consequences could include capital flows into the United States. That may sound pretty nice in theory, until you consider the consequences of strong dollar policies. An appreciation of the U.S. currency reinforces the outsourcing of labor to other countries which drives up domestic unemployment. When those jobs leave, it is very difficult to bring them back. Any taxes targeted specifically at exporting jobs would be a political landmine, but the incentives to export jobs are substantial. In addition to the strong dollar driving effective costs down, the lack of strict international worker safety laws lowers the cost of doing business abroad.

Quite simply the consequences of raising rates without a coordinated international effort could be severely damaging to the long term prospects of domestic workers. This isn't a problem that only impacts the United States; this is a problem for any country that needs domestic workers to have jobs. To the best of my knowledge, that still describes every country on Earth.

Possible Future Scenario

I think there is a decent chance that the Federal Reserve summons the courage to jack up rates for a quarter or two. If they manage to lift the longer ends of the yield curve or crash the price of equity REITs, I'd see either as a buying opportunity. If they do get rates up, they may find themselves forced to drop the rates back down subsequently due to the pressures of international trade.

The Way Higher

The one method I can foresee to really get rates going up on high credit quality bonds is to have an international agreement between central banks to raise the rates together. Such an agreement to raise short term rates throughout the developed economies would prevent the enormous capital flows. Doing so would result in dramatically less damage to employment rates.

I want to stress that the impact of low rates on employment is an international case rather than being a strictly domestic issue. Low interest rates simply are not stimulating enormous amounts of capital expenditures that would create an abundance of jobs. Corporations are not ramping up their capital expenditures; they are approving enormous amounts of share buybacks to drive up EPS by reducing the volume of shares outstanding. Thus the problem with raising rates is not that it would suddenly cause corporations to cut back on capital expenditures.

Because low rates are not spurring dramatic capital expenditures, a commitment across most developed nations to raise rates in unison should not be expected to drive global unemployment higher.


Absent an international agreement to raise rates, I simply don't see a path for the Federal Reserve to raise long term rates. They might be able to push up short term rates, but such a policy would still require disregarding their only two mandates. I'd love to see higher rates available on high quality securities, but any country trying to get there alone is just asking for punishment.

Investing Based on The Austrian School of Economics

By: Gordon Long

FRA Co-Founder Gordon T. Long discusses the Austrian School of Economics with John Butler and how its methodologies can be applied to the current global economy. John Butler has 18 years' experience in the global financial industry, having worked for European and US investment banks in London, New York and Germany.

Prior to launching the Amphora Commodities Alpha Fund he was Managing Director and Head of the Index Strategies Group at Deutsche Bank in London, where he was responsible for the development and marketing of proprietary, systematic quantitative strategies for global interest rate markets. Prior to joining DB in 2007, John was Managing Director and Head of European Interest Rate Strategy at Lehman Brothers in London, where he and his team were voted #1 in the Institutional Investor research survey. In addition to other research, he publishes the Amphora Report newsletter which appears on several major financial websites

  The Austrian School of Economics
"It is the no free lunch school of economics."
The Austrian school believes that economics systems are ultimately information systems. Some of those systems use information more efficiently and effectively than others, and in particular systems of which authorities of various kinds meddle with the market. Authorities may do this by extracting capital from the market via tax rates or even by manipulating the money of that market through some sort of artificial interest rate policy.
"From the Austrian schools point of view, anything that impedes the free price information flow of an economic system will result in a sub optimal economic outcome."
Without the rule of law, without the ability to strongly enforce property rights, without the ability to prosecute fraud, and various other legal frameworks; the Austrian economic model cannot work.
"Our goal is to make sure economic information flows as efficiently as possible within a solid legal structure."

How The Austrian School Can Be Applied In Investing

Austrianism teaches us that the future is unpredictable. The economy is made up of the billions of people in the world, with each person making transactions almost every day. Each decision is an individual's choice, and each decision, even the decision not to spend your money has some effect on the economy.
"Austrian school provides you a way to identify distortions, a powerful way that is caused by a fiscal and monetary policy set such as interest rate or fiscal policy manipulation. Austrians are able to look at these policies and be able to see how they are impacting the investment environment. This gives you a sense of where the distortions are. In theory you get an idea of where you should be overweight and underweight from an investor's point of view." 

 Current Events Amphora is Focused On
"Currently we are seeing a general overvaluation of risky assets that has been caused by truly an unprecedented set of highly expansionary monetary and fiscal policies throughout most of the world."
Income growth has not kept up; assets are expensive relative to incomes. So the correct strategy is not simply to short assets, which is dangerous; but if indeed they do look for ways to stimulate aggregate demand more directly rather than through the banking system.

The correct strategies to have today are those that will perform if incomes begin to catch up to asset prices, it could be asset prices declining towards incomes or vice versa. It is impossible to know which one is going to happen, but it is highly likely looking forward that a conversion of the two will happen.

  Possibility of Negative Nominal Interest Rates
"Policy makers have become almost pathological; they have a relentless attitude to make their policies work."

The Financial Repression Authority
"Problem with this is, once you get to this point, you can no longer question your original set of assumption. Austrian school of economics knows that the original sets of Keynesian assumptions that have gone into forming this unconventional and aggressive policy mix are themselves flawed. We are on this course where if it were left to run itself, policy makers will operation in these counter-productive directions because they will not question whether their assumptions are wrong." 
"Banning cash will prevent people from making even the simplest transaction in their own neighborhoods; it will lead to complete riot and chaos." 
"Putting a ban on cash is a terrible idea. It is terrible for them and for the economy as a whole. Sadly, with the way things are going, policy makers are going to teach everyone a very hard lesson about blindly accept anything the bureaucracy tells you to do."
 Central Banks Role if Asset Correction Occurred
"If you do get a major correction in asset markets that causes collateral problems in financial markets, the policy makers are out of options. The only thing they could do is begin capital controls."
Prevent investors being able to freely liquidate or withdraw funds from their existing investments. This of course is very anti-capitalist, very anti-market. It goes directly against everything that a free enterprise economy should stand for; but when you follow these policies you will eventually get to a dead end.