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The Fed Just Brought Us Closer to a True Market Crash

Never underestimate the incompetence of the U.S. Federal Reserve. By failing to raise interest rates, the Fed sent a strong signal that it believes the economy is weak. Now Fed inaction has brought us one step closer to a market collapse...

Federal Reserve Chairman Janet Yellen speaks with representatives of CONNECT, a coalition of local organizations that provides employment services in Chelsea, Mass., at the CONNECT office, Thursday, Oct. 16, 2014. (AP Photo/Michael Dwyer) AP Photo/Michael Dwyer

Do not underestimate the cowardice or incompetence of the U.S. Federal Reserve.

Last Thursday, after running out of domestic reasons to avoid raising interest rates by a paltry 25 basis points for the first time in nine years, the Fed decided to blame China for its policy paralysis.

By doing so, it effectively expanded its dual mandate from trying to achieve full employment and price stability to trying to maintain global financial stability. But this only succeeded in introducing additional uncertainty as to what the Fed’s function is and what it will do in the future.

Federal Reserve Chairman Janet Yellen speaks with representatives of CONNECT, a coalition of local organizations that provides employment services in Chelsea, Mass., at the CONNECT office, Thursday, Oct. 16, 2014. (AP Photo/Michael Dwyer) AP Photo/Michael Dwyer Federal Reserve Chairman Janet Yellen speaks with representatives of CONNECT, a coalition of local organizations that provides employment services in Chelsea, Mass., at the CONNECT office, Thursday, Oct. 16, 2014. (AP Photo/Michael Dwyer) AP Photo/Michael Dwyer

Does anyone else realize just how screwed up this is? And it gets worse.

Here’s why… and what I expect to happen now.

The Fed Is Focused on the Wrong Thing

The Fed remains focused on data that it doesn’t understand. It still believes the economy is suffering from a cyclical rather than a structural employment problem despite the fact that nearly 100 million able-bodied Americans (one-third of the population) are out of the labor force. It also believes that inflation is too low, despite the fact that the price of most goods and services are increasing rapidly.

The type of inflation they should be worrying about is the inability of income to keep up with debt service, but that crisis appears to be far beyond their ken. Debt keeps inflating while income can’t keep up, and keeping interest rates at zero will only make things worse.

Nonetheless, not being content to fumble their dual mandate, they have now added a third component to create a triad that is certain to lead the financial markets straight into another crisis – worrying about foreign economies like China.

In explaining the latest in a long series of policy errors, the Federal Open Market Committee said the following: “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”

In other words, China’s economy is tumbling and hurting the U.S. economy and the rest of the world. So, while Barack Obama and his team allow Russia and Iran to run America’s foreign policy, Janet Yellen and her colleagues are now ceding sovereignty over America’s economic policy to China.

This is truly pathetic.

An investor gestures in front of screens showing share prices at a securities firm in Hangzhou, in eastern China's Zhejiang province on August 24, 2015. Shanghai shares nosedived 8.49 percent on August 24 as Beijing's latest market intervention failed to restore confidence, with concern mounting about the stalling economy. (Photo: STR/AFP/Getty Images)

Of course, some might argue that this occurred years ago when China began financing a good part of our federal budget deficit. But that turned out to be a head-fake since a flood of other buyers of U.S. debt stepped out of the shadows when China stopped buying Treasuries – including none other than the U.S. Treasury! But the point is that China offered Yellen and her cowardly colleagues another excuse when they wanted to delay the day of reckoning until who knows when.

In her post-meeting press conference, Yellen explained that, “In light of the developments that we have seen and the impacts on financial markets, we want to take a little bit more time to evaluate the likely impacts on the United States” of an interest rate hike. By saying this, she effectively called into question the strength of the U.S. economic expansion, which was probably not her intent. But her caution has now lapsed into paralysis as she coddles spoiled financial markets heading into an election year.

So When Will the Fed Raise Rates?

It is now fair to ask if the Fed will ever raise interest rates with Barack Obama in the White House through January 2017. I believe the answer to this question is no. And if the answer turns out to be yes, the most the Fed will move before Obama leaves office is a nominal 25 basis points, which will accomplish nothing.

After all, if China was the excuse not to raise interest rates now, there is little prospect that China’s economy is going to improve sufficiently by the end of the year to justify a change of heart.

The Fed could decide to make a half-hearted 25-basis point move in December, but it would counter this hike with language reassuring markets that it won’t move again for a very long time. The purpose of such a move would be to put one interest rate reduction back in its pocket in the event of a recession or market crisis. Central Banks have no weapons left to rescue us. But 25 basis points is barely more than zero, and the prospects of any sustained series of interest rate hikes in 2016, an election year, are zero.

A more likely scenario is that the Fed will be tempted to begin more quantitative easing (QE) if the U.S. economy weakens as a result of more problems in China or other factors. The U.S. economy is growing at barely 2 percent. The 3.7 percent second-quarter GDP print is unlikely to be repeated – the Atlanta Fed’s real-time GDP tracker shows that third-quarter GDP was only 1.5 percent as of Sept. 17. With rates at zero, the primary tool at the Fed’s disposal is more QE.

Bottom Line: We’re One Step Closer to a Market Crisis

I have long feared that the Fed would wait too long and face a recession or a market crisis with no ability to lower rates any further. My fears are looking increasingly likely to come true. A recession looks far off with the yield curve still very steep and the Fed a long way away from any aggressive tightening moves. But a market crisis is a greater possibility.

After all, by refusing to raise rates, the Fed just sent a strong signal that it believes the economy is weak. That is hardly likely to boost the confidence of investors. Stocks are still trading well above historical valuation averages, and at some point investors could start selling again.

The dollar traded down from 95.42 to 94.39 on the Fed’s decision. It is still likely to strengthen in the months ahead unless the Fed panics and starts another QE program.

After all, the Europeans and Japanese are even more desperate than the Fed to cheapen their currencies and destroy the world.

TheBlaze contributor channel supports an open discourse on a range of views. The opinions expressed in this channel are solely those of each individual author.

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