In principle, I make a pittance off of any book sales from clicking on the links in any review that I write. But I will write about books that are “out of print” as well (no money there); whether in print or out of print, my goal is to serve readers by bringing important investment ideas to their attention.
Presently, I am reading Money of the Mind, by James Grant, but I have also read The Trouble With Prosperity, which is important to understanding our present circumstances. Both analyze monetary and other economic policies in the past, with an eye toward what it implies for us today.
In The Trouble With Prosperity, Grant’s main theme is what happens when monetary policy is perverted from trying to preserve purchasing power, to trying to assure a perpetual prosperity. He wrote this in 1996, when the US was recovering from the severe Fed tightening in 1994, which resulted from lax monetary policy 1991-1993, where the Fed funds rate was stuck at 3%.
As with most things, James Grant is right in direction, but early. Back in 1996, he could not envision a 1% Fed funds rate, much less the mysterious hypothetical helicopters of Chairman Bernanke. Capitalist economies are quite resilient, and can survive considerable mismanagement. Today we are far closer to what he worried about eleven years ago.
A central bank trying to assure continued prosperity will always be biased toward inflation. How the inflation manifests is a function of demographics. With a younger population, goods inflation will be stronger (buy more, save less), and asset inflation for an older generation (buy less, save more). At the same time, such a central bank will be biased against major losses in financial institutions.
The trouble is, the likelihood of the Federal Reserve rescuing troubled financial institutions raises the odds that the institutions will get into trouble. It skews the payoff to financial executives, and makes them more willing to take risk, because the institution will not be under threat if they fail.
In The Trouble With Prosperity, Grant walks us through:
- The puzzle of the markets in 1958, given the rise in interest rates and inflation
- A tall building that characterized the troubles of the Depression.
- The Japanese real estate and stock bubbles, and their deflation (still early in 1996)
- The S&L crisis in the early 90s
- Willingness to sponsor speculative ventures in the early 1990s, with a focus on gambling.
My opinion: low Fed funds rates foster speculation in healthy assets. Lever them up more, because we can. Ignore risk, and focus on the income one can generate today. Of course, the eventual risk is that the US ends up in a liquidity trap similar to the which the Japanese have been in for the last 17 years. Of course, the US economy is more flexible than that, but the risks are still significant.
Don’t view soft FOMC policy as a panacea. Eventually we will have goods inflation as a result. For now, the market is rejoicing in an accommodative Fed. Enjoy it while it lasts, buy inflation is coming.