Parmenides, in case you’re wondering, was “The Grandfather of Western Philosophy,” a fellow who lived in the 6th Century B.C., a generation or two before Socrates. And you now know pretty much everything we know about Mr. Parmenides, since he left only a fragment of one poem.
The Parmenides Fallacy was articulated not by Parmenides himself but by a professor named Philip Bobbitt. It’s best understood by retelling the old joke:
A guy is wandering around Times Square blowing loudly on a trumpet every sixty seconds. This is very annoying to people, and finally a lady walks up to him and demands to know what the hell he thinks he’s doing. “I’m keeping the elephants away,” the guy replies. “That’s ridiculous,” says the lady, “There are no elephants around here.” “You see,” says the guy, “It works!”
In other words, just because we do A, and B doesn’t happen, that doesn’t prove that A prevented B. In fact, we don’t know, and can never know, what would have happened if we hadn’t done A – if we’d done, say, X or Y or nothing. That’s an alternative future that never happened and is something we can only speculate about.
So, ok, what does all this have to do with our friends over at the Federal Reserve System?
Just this. Recall that before he became famous as the Chairman of the Fed, Ben Bernanke was known mainly as a scholar of the Great Depression. Among the questions Prof. Bernanke occupied himself with was why the Depression was so deep and lasted so long, a question that has long vexed economists. Bernanke’s conclusion was that the Depression was fueled and extended by the virtual collapse of the US financial system. As we know, many banks failed during the Depression and those that survived did so by hoarding their capital – in other words, by not lending it out. Since commerce thrives on credit, the lack of credit availability meant the economy could never gain traction.
It was an interesting theory, and possibly a correct one. But it would have been more compelling had not many other countries suffered through the Depression even though their banks did just fine. Or had not most of the failed US banks been in agricultural areas of the country, not commercial areas.
Fast-forward to the collapse of Lehman Brothers. Many people feared that the US – and possibly the global – banking system would collapse. Lehman, went the argument, was merely the first of the dominoes to fall.(1) Faced with this threat, the Fed went all-in, providing massive liquidity to the banking system and even allowing non-bank financial institutions (like Goldman Sachs, Morgan Stanley and AIG) to get in on the freebies. The global financial system didn’t, in fact, collapse.
But recall the Parmenides Fallacy: merely because the Fed did A (injecting massive liquidity) and B (the collapse of the financial system) didn’t happen, that doesn’t prove that A prevented B. The Fed seems to have missed this point.
As an aside, let me emphasize that I’m all for the Fed assuming the worst and acting decisively. Hell, maybe the global financial system would have collapsed after Lehman and we’d now be in the early stages of the Second Great Depression. Why take a chance?
But that doesn’t mean the Fed’s actions actually had their intended effect. Indeed, a lesser intervention might have led to better outcomes: Banks reduced from Too Big to Fail to Too Small to Bail. Investment banks that went bankrupt, a learning experience about leverage that might be remembered for awhile. A recognition by American citizens that Wall Street didn’t walk away scot-free.
Or maybe not. Who knows. And because nobody knows, it would have seemed prudent for the Fed to take a modest attitude toward what it accomplished or didn’t accomplish. Unfortunately, humility isn’t a core competence of central bankers. What the Fed seems to have taken from the experience was that Bernanke was right all along and that his actions prevented a Second Great Depression.
That in turn led the Fed to believe that it was vastly smarter and more powerful than it actually is, which led, finally, to QE2, Operation Twist, QE3, QE3.5, and the many other interventions in the markets that were not merely unconventional but flat-out unprecedented.
If all this intervention has helped, the evidence is scant. Unemployment remains very high, especially considering those who have given up finding work. The economy is growing pathetically slowly. Corporations won’t spend their cash hoards and families are still cutting back.
All that’s happened is that the Fed’s balance sheet has ballooned to breathtaking proportions and asset prices have shot up – especially commodities and equities. Since printing money didn’t appear to help much, the Fed now confidently predicts that the so-called “wealth effect” (investors who are feeling wealthier because prices of their stocks have gone up will go on a spending binge) will help pull the US out of the mire.
But, seriously, isn’t the wealth effect crock? Would the Fed itself believe in the wealth effect if its head weren’t already swollen because it thinks it prevented another Depression? Maybe the Fed has a lot in common with the fellow running around Times Square blowing his trumpet.
(1) The “Domino Theory” was also our excuse for going into Vietnam. Just saying.
Next up: Isn’t the Wealth Effect a Crock?
Please note that this post is intended to provide interested persons with an insight on the capital markets and is not intended to promote any manager or firm, nor does it intend to advertise their performance. All opinions expressed are those of Gregory Curtis and do not necessarily represent the views of Greycourt & Co., Inc., the wealth management firm with which he is associated. The information in this report is not intended to address the needs of any particular investor.