A veteran market watcher who saw the Fed creating a disaster in 2008 says ‘distortions in the economy’ today are still the Fed’s fault

Jerome Powell, chairman of the U.S. Federal Reserve, right, and Jon Cunliffe, deputy governor for financial stability at the Bank of England (BOE), prior to the central bank session of the G7 Finance Ministers and Central Bank Governors' Meeting in Niigata on May 13, 2023.
Photo by KIYOSHI OTA/POOL/AFP via Getty Images

When it comes to investors, bankers, and politicians, incentives matter. Not many writers know that better than Jim Grant, a veteran commentator who has worked in financial news for over 50 years, formerly at Barron’s but for himself since 1983, as the author of the weekly newsletter Grant’s Interest Rate Observer. The bespectacled and bow-tied Grant’s columns and many books have criticized money-printing by the Federal Reserve and stressed the flawed assumptions by a character he calls “Mr. Market.” A well-timed collection was 2008’s Mr. Market Miscalculates: The Bubble Years and Beyond, which the Financial Times approvingly reviewed at the time, with John Authers celebrating the many “uncanny examples of prescience” as well as Grant’s “crackling sense of humour.” This weekend, Grant argued that the Federal Reserve has ignored incentives for nearly a decade, and the economy is paying the price for yet another miscalculation.

“The Fed is problem No. 1 in American finance,” he told MarketWatch on Sunday, arguing the central bank has damaged markets and the economy for decades in ways that were “unintended but not entirely unforeseeable.”

Grant has foreseen many mistakes in his decades of watching markets. In 2004, for example, he warned that something was wrong at Washington Mutual—roughly four years before the bank’s collapse in September 2008. The number of risky mortgages where interest rates could be adjusted and principal payments deferred, called “Option-ARMs,” had jumped from 5% to 40% at the bank, he noted, putting average Americans at risk of losing their homes if the Fed raised rates.

“When the Fed lifted the funds rate in 1994, it caught out the hedge funds and interest rate speculators. When it raises the funds rate next time, it will catch out Mr. and Mrs. America,” Grant wrote in his 2004 column.

Time and time again over many decades, Grant has warned that rapid increases in interest rates after periods of historically low rates tend to catch both investors and CEOs off guard, leading to serious economic pain—and he sees the same pattern happening again today. 

Over the past 14 months, he notes, Fed officials have jacked up interest rates at an unprecedented pace in order to fight inflation, which hit a peak of 9.1% last June. Amid healing supply chains and fading commodity prices, they managed to slow year-over-year consumer price increases to 4.9% last month, but that’s still well above their 2% target, which means more rate hikes could be on the way. 

Higher rates are a big shift from what most investors and bankers have become accustomed to. For years after the Global Financial Crisis, and throughout the pandemic, the Fed kept interest rates near zero in an attempt to spur lending and investment in the economy. Grant argues that this so-called free money era incentivized investors and bankers to chase risky assets, as typically safe havens such as Treasuries, savings accounts, and investment-grade bonds didn’t generate significant returns.

“I think generally that the suppression of rates introduces all manner of distortions in the economy,” he explained. “It causes people to go and reach for growth, for yields as if they were on their hands and knees with a flashlight looking under their furniture for some return on their savings.” 

The risky assets that investors fought over during 2020 and 2021 didn’t perform so well last year amid rising rates, with tech stocks falling roughly 30% and cryptocurrencies shedding $2 trillion in market cap (or two-thirds of their previous value). 

Grant’s warnings echo those of another well-known financial commentator and author Edward Chancellor, who called inflation a “hangover” from central bank incompetence in early 2022. Later that year, Chancellor released The Price of Time, a history of interest rates, arguing that central banks have distorted the “natural rate of interest” many times over hundreds of years—with disastrous effects.

A goldbug’s lament

Grant believes years of low rates also led bank executives to hunt for increased yields, pushing them to invest in long-dated bonds that offered a slightly higher return but exposed them to problems if interest rates were to rise. He noted that many of the latest issues in the banking industry, including the collapse of Silicon Valley Bank and First Republic Bank, were related to this issue. Simply put, bankers bought assets that didn’t pay enough to cover their rising deposit expenses, and when investors noticed, it led to bank runs.

And Grant is worried that the Fed’s balance sheet has similar problems because it turned to a somewhat controversial policy called quantitative easing (QE) in the wake of the Global Financial Crisis in an attempt to spur economic growth. The central bank bought government bonds and mortgage-backed securities on the open market in hopes of increasing lending and investment in the economy and keeping interest rates low.

Grant’s many years of criticizing easy monetary policy has won him fans on the more conservative side of the political spectrum—or fans of classical economics. For instance, former Rep. Ron Paul, who became an unlikely dark horse presidential candidate in the 2012 Republican primary with his campaign to “audit the Fed,” cited Grant as his preferred replacement for Fed Chair Ben Bernanke. More recently, Grant has won positive reviews from the economics establishment for his biography of Walter Bagehot, the banker and former editor of The Economist who ironically influenced much of Bernanke’s financial firefighting during the Great Recession that followed the crash of 2008. On Sunday, Grant was criticizing Bernanke again.

“This idea that the Bernanke Fed surfaced in 2010-11, I think it is a very, very dicey proposition longer-term. I don’t think it works,” he said, referring to former Fed chair Ben Bernanke and QE. “The Fed, of course, isn’t First Republic Bank, but its balance sheet resembles that of First Republic and Silicon Valley Bank, in that it is earning 2% on its assets and paying 4-5% on its liabilities.”

Extended periods of near-zero interest rates can also incentivize increased government spending, as low rates keep the interest payments on the national debt subdued. But now, rates are rising, and with lawmakers hitting the $31.4 trillion debt ceiling in a time of increased political division, there’s growing concern that the U.S. could be unable to pay its bills—which Grant sees as at least partly a result of the Fed’s policies.

That’s why, for Grant: “The past 10 or 12 years in respect to Fed policy and the general suppression of the rate of interest” have laid the groundwork for the latest regional-banking problems and “debt drama.”

For investors, Grant says this means gold—the world’s oldest safe haven asset—is the only thing worth owning. Like his friend and supporter Ron Paul, Grant has long been what the finance world calls a “gold bug,” who thinks President Richard Nixon’s 1971 decision to leave the gold standard was a mistake, opening the door to a Fed run amok. And even now, with the Fed raising rates, he fears inflation will continue to be an issue, making gold a prized asset. Like a fire in a coal mine, we might not always see inflation, but it’s always burning, he says.

“I’m somewhat of a broken record on gold,” Grant told Schiff Gold in a July interview. “I’m going to continue with this broken record and observe that people have not yet come to terms with the essential inherent weaknesses of the monetary system that has been in place since 1971.”

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