by Charles Hugh Smith, Of Two Minds:

The Fed has backed itself not into a corner but to the edge of a precipice.

Though the Federal Reserve never stated its Grand Bargain explicitly, their actions have spoken louder than their predictably self-serving, obfuscatory public pronouncements. Here’s the Grand Bargain they offered institutional investors and speculators alike:

We’re taking away your low-risk, high-yield investments by slashing interest rates to near-zero, but we’re giving you endless asset bubbles as a new way to notch reliable gains. This trade-off has worked for 20 years as the Fed hyper-inflated one asset bubble after another until they finally inflated everything to precarious extremes: The Everything Bubble of 2019 that started unraveling in September 2019, long before the pandemic.

The Everything Bubble includes: stocks, housing, commercial real estate, corporate debt, junk bonds, CDOs, CLOs, bankrupt companies, phantom companies, etc. The Fed inflated all these assets bubbles as a “can’t lose” proposition for yield-starved institutions that can’t survive on low-risk 1% Treasury yields.

These institutions include: public union pension funds, insurance companies, mutual funds, wealth management entities, hedge funds, banks and 401K retirement fund managers.

Asset bubbles are not a substitute for Treasury bonds and AA-rated corporate/municipal debt for one reason: risk. Despite all the extravagant claims about risk being hedged, the reality is that risk cannot be made to disappear, it can only be transferred to others.

Asset bubbles are intrinsically unstable and therefore risky. All bubbles pop, period, and whomever is holding the bag as the bubble pops will suffer catastrophic losses. The Fed and its countless apologists / lackeys claim the Fed has our back and so bubbles will never pop because the Fed will print as much money as needed to reflate any bubble that’s losing air.

After unprecedented asset bubbles popped in 2000 and 2008, the Fed apologists / lackeys all claimed the bubbles only popped due to a policy error. If only the Fed had (insert policy: waved more dead chickens over the bonfire, danced the humba-humba with Paul Krugman, bought bat-guano futures through offshore proxies, etc.), then the bubble would have continued expanding to infinity: Dow 100,000, yee-haw!

This fantasy ignores the dynamics of bubbles: when bubbles reach extremes, they implode regardless of policy tweaks and media appearances.

The Fed lowered rates to bring demand forward and lower the cost of additional borrowing by households, companies and governments, the goal being to stave off recession and encourage speculative gambles in housing and stocks that would generate the wealth effect to further stimulate imprudent borrowing and spending.

Don’t put off buying that new pickup, the Fed screamed; buy it now while rates are near-zero. (Buying what you would have bought next year right now is bringing demand forward.)

The problem with bringing demand forward is eventually there’s no demand or credit left to buy more stuff because all the demand was brought into the present and only the most marginal borrowers (and those who refuse to borrow more no matter how low rates go) are left.

Read More @ OfTwoMinds.com