Running Scared To Deny Reality

Running Scared To Deny Reality

By |2014-12-01T13:24:47+00:00December 1st, 2014|Economy, Federal Reserve/Monetary Policy, Markets|

It has been lost to history now, but the first stirring of rational expectations theory was something like daylight savings time. “Experts” posited that there could be calendar effects lurking in behavior that might be exploited with the right kind of regulatory agenda and even interference in something so established as Thanksgiving itself.

As Pat Horan at RealClearHistory details, FDR moved the holiday in 1939 because the final Thursday in that November fell on the 30th. Ever one to interfere in favor of economic management, Roosevelt was entranced by the suggestion from various retailers and trade groups that holiday spending might be enhanced by coming a week earlier.

Fred Lazarus, Jr., the founder of the Federated Department Stores (later merged with Macy’s), supposedly convinced FDR to move Thanksgiving a week earlier to extend shopping season in order to help merchants boost profits. Commerce Secretary Harry Hopkins also advised the president to change the date.

Leave it to depressions to lean toward such top-down approaches to the economy. It doesn’t even pass common sense as it’s not as if people get paid more in having Thanksgiving on November 23 as opposed to November 30, but rather only counting that what might be saved by consumers in that earlier week will be instead be spent. And so it was perfectly consistent with that insidious root of 19th century “economics” that all saving is bad and unfettered consumption is the basis of all expansion.

Of course, there was no discernable impact from the “Democrat Thanksgiving”, or as Mr. Horan notes, “Franksgiving.”

The battle over the holiday continued for the next two years as FDR proclaimed Thanksgiving a week earlier. A week earlier in 1940 and 1941 meant celebrating on the third Thursday of the month. However, with most retailers, the intended beneficiaries of the change, disapproving and little evidence indicating an increase in sales, Roosevelt acknowledged his experiment a failure and signed a resolution passed by Congress, designating the fourth Thursday of November as Thanksgiving Day.

Rather than finding permanent disfavor, the idea of such manipulation in kind if not just in spirit was “refined”, especially in the decade of the 1980’s. The Great Inflation had moved many economists to view with growing distrust the sense of “markets.” Rather than ingest market prices as indicative of what is important, reform was turned outward as to how people were too imperfect as to follow the course “expertly” laid out by central planners.

It was recession itself where this transition seems to have gained the greatest unease, as current orthodoxy dismisses the business cycle almost entirely to unsuited emotion. If you read their academic work, even of Janet Yellen, the word “pessimism” litters the theories and “conclusions.” Recessions are creatures of “undue” pessimism, so the central bank takes on the role of psychiatrist-in-chief – if Janet Yellen, like Ben Bernanke and Alan Greenspan, can convince you and everyone like you that conditions will be better in the near future, then you will act on those expectations today.

In that sense, the central bank does not even have to do much of anything, as such moral suasion on a gigantic scale does the work for it. As long as you are convinced away from “unwarranted” pessimism, there can be no recession (which says a lot about the foundation of orthodox theory of recovery – a man may not be able to live on bread alone but an economy shall be sustained by nothing more than good feelings?).

The logical extension of that is where we find ourselves today. What might happen when things go “soft” and unease becomes paramount? Rational expectations theory more than suggests misdirection and even downright falsehoods. The central banker, keenly aware of the role of perception and expectation, will always and everywhere be positive even when there is an overriding sense that such positivism is, in fact, the feature that is very much unwarranted.

Oil prices are not a collapse in demand, and thus a signal of global re-recession but rather an overwhelming fracking success. And even if it is related to demand, that’s good for consumers – who are simply believed too uneducated as to notice that sharp contradiction about “inflation” and the assumed dangers of the dreaded “deflation.” Great convolution is created from trying to stretch positivism to all corners.

For all the public bluster, however, policymakers are indeed scared witless by it.

Despite undershooting the goal for three years, the Fed has long succeeded in convincing markets that the target was within reach. However, inflation expectations have begun slipping in recent weeks, threatening to amplify downward momentum from plunging energy prices and stuttering global growth…

Other officials, who declined to be named, were not ready to sound alarm yet but said that if inflation continued to disappoint the Fed would have to admit it did not know how long it could last, or how it might shape longer-term expectations.

Do they admit what is obvious? Nope:

For now, however, most policymakers opt to stick with the tried-and-tested theory that monetary stimulus and accelerating growth will eventually lift inflation and fear that airing their doubts could make the Fed’s target even harder to accomplish.

Reflecting such fears, the Fed’s Oct. 29 policy statement left out references to recent market turmoil and economic weakness in Europe, Japan and China, while downplaying a drop in market-based inflation gauges.

The suggestion here is that these are minor cracks in an otherwise robust economic system, a bump in the road. The problem with that “narrative” is that it is far too narrowly defined, as we found out once again with a very black Black Friday. The larger point here is actual economic growth, to which inflation is supposed to equate in orthodox understanding. If the Fed is actually concerned about inflation falling further in the US, they are really saying they are worried about the overall economic trajectory.

Beyond that, the implications are actually also quite severe. There is a growing body of evidence (aided by pure common sense, but economists prefer esoteric regression constructions to simple and clear logic) that QE totally failed, which, in this context, is a severe complication (to put it mildly). Again, rational expectations theory rests upon the central element of faith in central banks’ ability to actually deliver something other than the contradiction of stock prices to actual labor conditions. In fact, such divergence works directly against such positivism as it is a painful reminder of all that remains unresolved (and thus ineffective).

They will never admit that the economy may be far worse than the “narrative” suggests because they cannot allow expectations to “anchor” anywhere but hopelessly positive. Like “Franksgiving” however, the flaw in the theory is not the results but the premise. Underconsumption has been rebranded several times over the past century and a half (now neo-Keynesian, incorporating the main elements of monetarism like expectations), which is all you really need to know about its ultimate efficacy. Consumers cannot take positive thoughts, even from Janet Yellen, to the grocery store or to shop at on Black Friday with “it will be better tomorrow”, but they are expecting you to do exactly that though debt.

Spending is derived from income, which is not a function either of positivism but actual wealth. Unfortunately, this overarching dependence on rational expectations theory and “aggregate demand” is the statist drive to erode wealth creation. Monetary policy, as in only slight absurdity, is very much against rising wages (as that is “inflation”) and very much for higher prices (as that “anchors” expectations in the “right” direction). If that wasn’t enough to harken attrition, they then emphasize asset prices over everything else especially productive investment.

In that sense, the Fed is finally coming to terms at least internally, after totally ignoring what really happened in the Great Recession, to its attempts at engineering recovery by stamping out wealth creation; to the point they now are afraid that there hasn’t been enough wealth creation.

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