The Fed’s Secret Plan, by Robert Gore

Judging from last week’s action, the equity and corporate debt markets didn’t get the memo that the precipitous decline in oil was a tax cut, an unambiguous blessing for the US economy. America consumers were going to take that tax cut straight to the malls or internet and give retailers a Christmas stocking full of goodies. And they may well do so, but scratch the “unambiguous blessing” from the stories about falling oil prices; turns out there’s some ambiguity after all.

Up until its price dropped, the oil market was a poster child for the Federal Reserve’s policies. Plentiful and inexpensive money had kept oil’s price elevated and made financing the “boom” a snap. Unfortunately for the Fed, as SLL has noted, the marginal return on investment equilibrates to the marginal cost of capital, so as production increased, its expected return declined. Humans being human, booms get people overly excited, and often the expected returns goes negative, especially when the cost of debt is thrown in. Now there is nothing “expected” about negative returns in the oil patch, and suddenly, nobody wants to lend money to oil producers.

This presents a quandary for the Fed. It’s bent all its efforts the last six years to preventing deflation, and here deflation, with a capital D, arrives in the oil patch. In the Keynesian world view of the central banking cohort, debt is the fountainhead and sustenance of an economy, but there’s a bit of an aversion to existing oil debt. And new debt? No way. There’s nothing to worry about, however, for the PhD brain trust at the Fed is working on a secret plan that will turn frowns into smiles and as a side benefit, propel the Dow past 20,000.

Like all great plans, this one is simplicity itself: the Fed is going to mop up that oil glut its policies were so instrumental in creating. That’s right, the Fed is going into the oil business! It’s new policy will be called “petro-easing.” Why should central bank money printing and balance sheet expansion be limited to pieces of paper? In fact, petro-easing is better than quantitative easing, because the Fed will be getting back something tangible for its created-from-thin-air money, not some junky security like government debt from a bankrupt government. Not only will this move rescue the oil market, but from it will flow more of the usual benefits of quantitative easing—artificially low interest rates, malinvestment (including more malinvestment in the oil patch), cheap funding for banks, financial asset price boosting, and money in the pockets of leveraged speculators with access to cheap credit, who in turn can keep the purveyors of luxury items and services afloat.

Petro-easing presents a few problems. Won’t the Fed’s policy hinder markets’ responses to overproduction—cutting back production, reducing employment, repricing oil assets and debt, and all the other ways markets align demand with supply? What will the Fed do with all that physical oil as beleaguered producers the world over, including the governments of Venezuela, Russia, Iran, Nigeria, and Norway, slam its bid? Not to worry. Modern central bankers never have to acknowledge market forces, they just create more money. As for all that oil, maybe the Fed can buy refiners and gas stations. If that sounds absurd, so too does the idea of central banks buying government debt and other financial assets to promote prosperity. No proposition is too absurd for today’s central bankers.

WHAT WOULD WE DO WITHOUT A CENTRAL BANK?

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