The Austrian

The Fed's Confidence Game

crystal ball

THE AUSTRIAN: As Austrians, we’re often noting that we seek to explain and describe economic cycles, and not necessarily predict what’s going to happen next week. So, how would you describe and explain the state of the economy right now?

MARK THORNTON: That is right. Austrian economics enlightens you about what will happen but not when and how much. Right now all the headline numbers are very good. The unemployment rate and the consumer price index (to the extent that you can believe them), along with the stock market all look remarkably well. However, we have had nearly nine years of historically low interest rates and that signals trouble ahead.

Not surprisingly, as a result of Fed policy, total household debt (mortgages, credit cards, auto and student loans) is fast approaching a record-breaking $13 trillion. Investment in real estate and elsewhere is also at or close to bubble levels. There has been an enormous transfer of wealth from the middle class to the very wealthy as well. So, all the facts seem to line up with the Austrian business cycle theory.

TA: How do you think the economists at the Fed view things? Do they have an endgame in mind, or are they just trying to weather each crisis as it comes up?

MT: There are the public statements that Fed officials make to increase, or at least maintain consumer and investor confidence. They have a “confidence game” approach. Retired Fed officials have admitted that they cannot make public forecasts of recessions. According to the Fed the economy only gets better over time and we are never headed into a recession.

Of course they would like to normalize interest rates and their balance sheet, but they know that would create enormous problems. For example, the Fed’s monetary policy has created an enormous number of zombie companies, so if interest rates and expenses increase, then these companies would be forced to restructure and lay off workers. They continue to talk of “green shoots,” “normalizing interest rates,” and “selling off the balance sheet,” but they have not achieved any of this yet. Don’t hold your breath.

TA: At this point, we’ve literally been hearing from the Fed since 2009 that they’ll be normalizing monetary policy any day now. What do you think is the biggest reason that they’ve been so afraid to normalize? In other words, why hasn’t the current recovery been enough for them?

MT: When you look below the headline numbers, you see problems. I mentioned the zombie companies above. If interest rates go up they will start to show bigger losses. The auto industry has used low rates and subprime auto loans to sell cars. Now the manufacturers see growing inventories at all time high levels. Auto lenders have also hit an all time high in terms of the average length of loans, now close to six years. Auto dealers are bombarding the airwaves with deep discounts and zero financing. Throw in higher interest rates and the implications for manufacturers, employees, and consumers are all very negative. There are similar scenarios throughout the economy.

Also, dependency on government and private welfare is at a very high level in America, so is economic fragility in terms of employment and savings. The Fed knows all this and is therefore very leery of igniting a recession.

TA: If you look for them, it’s always easy enough to find perma-bears saying somewhere that the economy is about to crash. We’ve been hearing that for years, but things continue along fairly evenly, even if weakly. Our sense, though, is that the Fed seems more concerned now than before, and that maybe they’re backed in a corner. Is this just our imagination?

MT: No it’s not your imagination. This cycle is different because of all the unorthodox and unprecedented monetary policy. I was bearish going into the financial crisis, but the economy got hammered with QE and then again with QE2. I thought a zero federal funds rate was as far as they would go and that they would normalize their policy as past Fed leadership had done. So that was a big surprise. I consider the Fed’s policy to be irresponsible because of what it has done to the American people and to the structure of the American economy. In addition, their interest rate policies have allowed Congress to double the national debt (in absolute terms and as a percentage of GDP) in a very short time. A doubling of interest rates would now cause interest payments by the federal government to roughly double from $500 billion to $1 trillion.

TA: 2017 is nearly over. Have there been any big surprises for you in terms of central banks this year, or have things proceeded much like you thought they would?

MT: Things have proceeded pretty much like I thought they would. Central banks do not like surprises, except the positive surprises of printing more money and reducing interest rates such as QE and QE2. They try to manage expectations. They claim one more rate hike in 2017 (probably in December) and three more in 2018. That is when things should start to get interesting whether they hike rates or not.

The story I am watching from my vantage point in Auburn, Alabama, is the expansion of capacity in terms of commercial and retail space and apartments. Some of it has already come online while more is under construction. All this new capacity means more debt, but will it also result in lower prices and profits? Auburn University has also undergone a mega building program in recent years. The City of Auburn is also building and upgrading infrastructure, schools, parking, and city hall. We have never seen anything like it.

Of course I am also watching the construction of the Jeddah Tower in Saudi Arabia. It is planned to be built to a new record height and according to the Skyscraper Index could bring about a “Skyscraper Curse” or economic crisis in the near future.

TA: You stated above that the bubble economy has transferred wealth from the middle class to the wealthy. This reminds us that bubbles affect different groups differently. When the bubble finally bursts, which groups stand to lose out the most and why?

MT: The general pattern is that capitalists gain from cheap credit and labor is hurt by price inflation on the upside of the cycle. On the downside capitalists and the wealthy lose the most as asset values, like stock prices, collapse, while labor is relatively better off from lower price inflation or even deflation, e.g., lower home prices. This past cycle was different because of the bailout of the wealthy (which helped cause Donald Trump to be president). Those bailouts could happen again, but those bailouts distort the correction process which requires a complete adjustment of relative prices.

Mark Thornton is a Senior Fellow at the Mises Institute and the book review editor of the Quarterly Journal of Austrian Economics. He has authored seven books and is a frequent guest on national radio shows.


Thornton, Mark, "The Fed's Confidence Game," The Austrian 3, no. 6 (2017): 16–18.

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