Former Fed Governor Predicts “Wrenching” Market Adjustment

Lawrence Lindsey, a Governor of the Federal Reserve from 1991 to 1997, was right before. And got fired for it. Reality was too inconvenient.

In December 2002, as George W. Bush’s economic adviser and Director of the National Economic Council at the White House, he fretted out loud that the invasion of Iraq would be a lot more expensive than supporters of it were claiming. Clearly he’d failed to drink the Kool-Aid. Instead of peanuts, it would cost as much as $200 billion, he said. It shook the White House at its foundations, the fact that he had the temerity to say this.

The Atlantic explains:

Bush instead stood by such advisers as Paul Wolfowitz, who said that the invasion would be largely “self-financing” via Iraq’s oil, and Andrew Natsios, who told an incredulous Ted Koppel that the war’s total cost to the American taxpayer would be no more than $1.7 billion.

As it turns out, Lawrence Lindsey’s estimate was indeed off — by a factor of 10 or more, on the low side.

So maybe people should listen to him. And maybe, if his record repeats itself, the disaster he warns about is going to be a lot more costly in the end than the worst-case scenario he is now predicting.

Lindsey was speaking during a panel discussion on Fed policy at an event sponsored by the Peterson Foundation, MarketWatch reported. And once again, he dared to say what everyone already knew, but what the financial establishment on Wall Street fights tooth and nail: The Fed has dragged out the normalization of interest rates “way beyond what is prudent.”

He explained that in graduate school, if you suggested that the federal funds rate should be kept at zero while the unemployment rate is 5.4%, which is exactly what the Fed has been doing, “you would have been laughed out of the classroom.”

“At some point we’re going to get a series of bad numbers, showing a little higher inflation, and the market is going to say ‘on my god, we’re so far behind the curve’ and force an adjustment that is going to be wrenching,” he said.

According to his calculus, when this “wrenching” adjustment kicks in, it would turn into a market disruption at a level “seven or eight” on a scale of 10, with 10 being the worst.

But that’s the guy that warned that the total cost of the Iraq invasion would be $200 billion, instead of peanuts, and later it turns out to amount to $2 trillion. So by how much is he underestimating the ultimate debacle with his prediction of a “wrenching” adjustment of “seven or eight” on a scale of 10? Maybe we’re better off not knowing the answer.

So what should the Fed do to mitigate the risk of this sort of bone-chilling bond market? Start hiking rates. Start with modest hikes. But start in June.

But it may already be too late. He said the Fed “has almost no credibility” with his clients about its ability to “stay on top of ticking monetary bomb.”

Stocks are at all-time highs. The party is just too fun to walk away from. Money is once again flooding into even distressed energy-related junk-rated companies that are once again able to sell bonds on a wing and a prayer because yield-starved investors, brainwashed by the Fed’s interest-rate repression, are chasing yield wherever they can find it, no matter what the risks.

Times are good, and everyone is having fun now. But it won’t last: “the market is going to take the Fed and the Treasury curve to task in a very painful way,” he warned.

Rate hikes would have a long way to go: If the Fed raised rates by a quarter percentage point at every other meeting starting this June – oh my, can you see the tantrum already? – monetary policy would not actually be restrictive until December 2016, he said.

Going that far, ever, though it would only mean going back to “normal,” would be plain unthinkable for Wall Street hype mongers that have conniptions every time the Fed contemplates raising rates just once, and just a quarter point, just to show that it’s still there, even if it has no intention whatsoever of staying on “top of the ticking monetary bomb.”

A disturbing scenario is already playing out for folks fretting about “financial instability,” as it’s called in central-bank jargon. Read… “Buyers beware”: Capital Markets “Completely Backwards”

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  17 comments for “Former Fed Governor Predicts “Wrenching” Market Adjustment

  1. Mike R. says:

    The current rebound in the economy (uneven and selective geographically) is not organically driven. That is, it is not the result of true wealth generating fundamentals. It’s a result of free money percolating through the system. The free money (QE) has stopped flowing pretty much but there is a lag time until the economy shuts back down. Perhaps a couple of years total. We’re in the second year since the QE spigot was turned off. By the end of 2015, most of this development nonsense (apartments everywhere) and stock buybacks will have run out of free money.

    So the Fed can start raising interest rates, but they’ll be doing so in the face of a rapidly declining economy; evidence of which is all around us in spite of pockets of “boom”.

    Everything comes to a halt when even debt saturation occurs at 0%. That is no-one needs or wants the 0% money. We are not far from that happening.

  2. Petunia says:

    All that free money didn’t go to the people that really needed it. Department store credit cards are charging 29% interest, credit cards 15%, if you still have either. This is why no one is spending, no jobs or low incomes, bad credit or no credit. The people getting the QE money are just wasting it on stock buybacks, $100M houses, and art. The productive class is being shut out while the parasites are being given free blood.

    • Ken says:

      Petunia
      Don’t understand why economist can’t see your point. The average worker has not benefited from QE and low interest rates. Rate increase in this fragile economic environment will prove only one point, the Federal Reserve is a danger to our economy and have a atrocious track record
      Ken

  3. Julian the Apostate says:

    You tell ’em, Petunia. We have crossed the Rubicon; we are past the point of no return. It must now exhaust itself before the pendulum can swing back.

    • Jerry Bear says:

      The last time insanely speculative Wild Street types caused a huge crash, many of the them did the rest of us the favor of taking that giant “jump to Jesus” voluntarily from their skyscraper windows. This time around they might need a little boost….. I think the technical term is “defenestration”. Of course I am just fantasizing but I get a considerable amount of relish envisioning it all the same. Hee Hee! ^,..,^

      Bloody mindedly YOurs, Jerry Bear

      • Gerard Pierce says:

        It’s an interesting and cheerful thought, but times have changed — defenestration doesn’t work because the windows no longer open.

  4. Vespa P200E says:

    IMHO – I can’t see the Fed ticking up the interest rate this year. Too many crosswinds and resulting in meltdowns of appreciated assets of all kinds… So what to do but to kick the can down the road with more easy money/liquidity to extend the drunken stupor.

    Global markets got drunk on QE and ZIRP for sometime and will have hell of hangover tantrums if the easy money spiked punch bowl is taken away. USD is strong while the real economy really didn’t get out of the Great Recession, and with other currencies resorting to depreciation to boost exports raising of US interest rate will result in stronger USD (something US based multi-nationals won’t allow via well connected political contributions to both crook parties).

    So round and round it goes where it will stops nobody knows until 1or 2 black swans appear and bring the inflated assets back to earth…

  5. NotSoSure says:

    The Telegraph has an article pretty much saying the same thing:http://www.telegraph.co.uk/finance/comment/jeremy-warner/11616509/Jeremy-Warner-How-Iraq-has-left-us-with-the-biggest-financial-bubble-in-history.html

    Other than that, can someone somewhere please explain who/what “the market” is? In the past, “the market” means the absence of the Fed, and the presence of many independent players. I want to know how an adjustment will happen if The Fed + Its Thugs == 90% of the market? They can draw a rotation quota allowing members to make profits in turn.

  6. michael says:

    The FED will raise rates sooner and faster than wallstreet or its media puppets prefer. Inflation that goes unmeasured in the government metrics must be unwound. Dollars sent around the globe return seeking a safe hiding place and yield.

  7. Rodya says:

    I don’t understand where all this inflation will come from, only low paying job with no wage increases.

    Only inflation is stock market, bonds and home prices, but doesn’t seem those create “too” much spending.

    Waiting for inflation will be a few boring years.

    • NotSoSure says:

      It will come but not now. And that’s where the bears and the doomers are wrong IMHO. They were expecting hyperinflation right away, but that can’t happen until a somewhat prolonged period of deflation. Afterwards, Congress itself will demand that the Fed buys helicopters to drop wads of cash on people’s backyards to save the American way of life. After that it’s off to the races.

      • Genevieve Hawkins says:

        Interesting theory. I’m trying desperately to deflate the value of everything I need as fast as I can–we have an extensive garden and some fruit trees, and our neighbor gave us some of their harvest of nectarines just tonight. At what point do people walk away from the money (or credit, electronic debt instruments, fiat legal tender, etc) realizing that it’s a game of playing with somebody else’s monopoly money? At what point do the digits on the computer screen become worthless? At what point does cash suffer the same fate?

        • Petunia says:

          In the third world they use the currencies of real economies over their own because they have more confidence in them. That will happen here too. They think they can go digital and people will have no options but that is not so. I envision private atms spitting out foreign currencies everywhere and people transacting in multiple currencies. That will be the unforeseen consequence of all the financial repression coming from Washington.

    • Jerry Bear says:

      Exactly! Genuine inflation implies too many dollars chasing too few goods. In our case we have too few dollars chasing too many goods. The only way to have “inflation” under current circumstances is to artificially conjure it out of thin air, but dont think the Fed wont try! If they really want to improve things, they need to restart QE but this time direct it towards the people by fully funding food stamps and unemployment, medicaide and Medicare and big bonuses for Social Security and housing support. This will greatly increase consumption which will increase business activity and reduce unemployment and create a basis for inflation. this would accomplish far more than throwing the same amount of money at Wall street.

  8. interesting says:

    “Andrew Natsios”

    does this guy still have a job? how can you be that wrong and still find employment?

  9. Julian the Apostate says:

    Are you kidding? It’s a resume enhancement! I guess you’d have to put me in the doom and gloom camp, though oddly enough I’ve never been one before now. There has been a very rapid acceleration into the endgame. Right now the dollar is strong by default, but when it loses it’s appeal and floods back into the country THATS when the hyperinflation will start. Everything has become so intertwined and interconnected that when some part of it snaps it’ll take everything else down with it. Capital controls will disable the release valve and like an overheated steam engine it will burst and take out anything nearby. The funny thing about reality is that it really doesn’t care whether you’re wearing rose colored glasses or are a doom and gloomer, it will take everybody down. And I’m sorry kiddies barter just ain’t going to cut it. NUFF said.

  10. Jerry Bear says:

    Nowadays no currency is strong, they are all weak and threatened because the world economy is weak and threatened. It cannot work to “improve” the economy by reducing imports and increasing exports and austerity measures if every country in the world tries to do it. This can only result in severe depression of international trade and that is exactly what is happening. A healthy currency implies healthy international trade. If hyperinflation occurs in the presence of high poverty and unemployment then it will lead to outright starvation. The starving have nothing to lose by fighting as they well know a quick death beats a slow one, This will create dire revolutionary conditions…

    Anyway Julian, we are all getting doom and gloomy. It is the appropriate response to current conditions. I am finding out I am far from the only one who feels that all hell is about to break loose.

Comments are closed.