Our expectations for a global economic downturn, including a U.S. recession, have hardened considerably in the past few weeks, with a continued expectation of a retreat in equity prices on the order of 40-55% over the completion of the current cycle as a base case... A 40-55% retreat in the S&P 500 would take the most historically reliable valuation measures only to their historical norms, so I continue to view that outcome as a run-of-the-mill expectation


The immediate conclusion that one might draw [from the macro view] is that the Federal Reserve made a "policy mistake" by raising interest rates in December. But that would far understate the actual damage contributed by the Fed. No, the real policy mistake was to provoke years of yield-seeking speculation through Ben Bernanke's deranged policy of quantitative easing, which propagated like a virus to central banks across the globe. The extreme and extended nature of the recent speculative episode means that we do not simply have to worry about a run-of-the-mill recession or an ordinary bear market. We instead have to be concerned about the potential for another global financial crisis, born of years of capital misallocation and expansion of low-quality debt both here in the U.S. and in the emerging economies.


The Fed repeatedly fails to consider the full consequences of its actions even though they are baked in the cake, so they only feed into changes in policy once the financial system is in crisis and the Fed's target economic variables - employment and inflation - are directly affected. The result is waves of expansion and collapse that are wholly unnecessary.

This rolling tsunami could be largely avoided if the Fed was to reduce the [time until consequences arrive] by giving timely and direct attention to the financial consequences of yield-seeking distortions and misallocation of credit produced by its own activism. By waiting until those consequences show up directly in employment and inflation, which are themselves only weakly related to Fed actions, the present conduct of monetary policy virtually guarantees a recurring cycle of bubbles, crashes, and economic crisis.

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