The Albatross Of Debt: Why The Fed’s Wall Street Based Steering Gear No Longer Drives The Main Street Jalopy, Part 6

The heart of the Fed’s monetary central planning regime is the falsification of financial asset prices. At the end of the day, however, that extracts a huge price in terms of diminished main street prosperity and dangerous financial system instability.

Of course, they are pleased to describe this in more antiseptic terms such as financial accommodation or shifting risk and term premia. For example, when they employ QE to suppress the yield on the 10-year UST (i.e. reduce the term premium), the aim is to lower mortgage rates and thereby stimulate higher levels of housing construction.

Likewise, the Fed heads also claim that another reason for suppressing the risk free rate on US Treasuries via QE was to induce investors to move further out the risk curve into corporates and even junk, thereby purportedly boosting availability and reducing the carry cost of debt financed corporate investments in plant, equipment and technology.

In a word, the modus operandi of Keynesian central banking is to replace free market prices on bonds, loans and other financial assets (including equities) traded on Wall Street with administratively set prices designed to stimulate increased levels of real activity in targeted sectors of main street.

The giant flaw on the whole enterprise, however, is that the central bank does not operate in a vacuum in either space or time. Nor does its crude steering gear of administered financial asset prices have any reliable connecting rods to the main street economy.

That’s especially the case because under conditions of Peak Debt in households, cheap mortgages aren’t efficacious; and owing to Peak Speculation on Wall Street as described below, cheap debt gives rise to financial engineering in the corporate C-suites and pure, undisciplined gambling on Wall Street.

With respect to what we have called the “spatial” dimension, for instance, the artificially suppressed yield on the benchmark UST can easily transmit through the risk curve to cheap junk bond funding for an LBO rather than enhanced investment in capital equipment.

The latter would tend to improve efficiency or capacity and therefore boost broadly based wealth. By contrast, the LBO would tend to actually retard GDP by encumbering existing productive assets with much higher interest expense and also with short-run needs to slash capital and operating costs—even if that diminishes long-run productivity and growth capacity. Having spent 15 years in the private equity business, in fact, that is one thing your editor is especially sure about.