The Fed Just Brought a "Super Crash" Closer

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

Yesterday (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.

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

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.

I want to show you why… and what I expect to happen now.

The Fed Is Focused on the Wrong Thing

federal reserve
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.

This all goes back to the Debt Supercycle I told you about in my Super Crash Report.

Nonetheless, not being content to fumble their dual mandate, the Fed 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, again, 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.

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 Mrs. 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, Mrs. 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 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 Mr. 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. As I told you, central banks have no weapons left to rescue us (Super Crash Inevitability No. 4). 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 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%. The 3.7% 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% 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.

Hang in there. As I keep telling my clients and my readers, we’re getting closer to an “inflection point” that represents a tremendous opportunity for you to make some serious money.

Follow us on Twitter @moneymorning.

Editor’s Note: Now that the Fed has practically ensured a market crisis, it’s time to move. We’re urging all our readers to download Michael’s full “Super Crash Report.” Click here to get it free – as well as his follow-up Sure Money reports at no charge, so you can get all of the actionable protective moves and profit recommendations (yes, there is upside) as this plays out.

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