Tuesday, December 16, 2008

Truly Frightening News from the Fed

I know that I post a lot of scary stuff here. I have been frightened for some time. I sold all my US stocks in the spring of 2007, and foreign stocks in the fall of that year. Things were beginning to look bad back then. The first event that really had me scared, though, was the failure of Bear-Stearns and the massive Fed interest rate cut that occurred nearly simultaneously. For a month, I literally stockpiled canned food. I was scared witless. I've calmed back down since then. Even the crash of October did not scare me much, as I had been short the market and prepared for it since March. I was handling things rather swimmingly, all things considered. Until today. I am now even more frightened than I have been at any point since the crisis started. What did it? This report.
Dec. 16 (Bloomberg) -- The Federal Reserve cut the main U.S. interest rate to as low as zero for the first time and shifted its focus to the amount and type of debt it buys, seeking to revive credit and end the longest slump in a quarter- century.
Even worse:
Today’s vote was unanimous. In a related move, the Fed lowered the rate on direct loans to banks and securities dealers to 0.5 percent. It set the payment on the reserves that commercial banks hold at the Fed at 0.25 percent, down from 1 percent.
That last sentence, coupled with the Fed purchasing assets, should scare the living daylights out of us. If it follows through with this, the end of the Republic could be at hand. I have remarked before about the stratospheric increase in the AMB as a result of the TARP program. I have also remarked that this money has not made it into circulation as a result of the problem of "pushing on a string," which has been aided by the new policy of the Fed paying interest on reserves held in its vaults. Now the Fed has cut that rate, reducing the incentive for banks to keep that money out of the credit markets. If the Fed begins buying other types of assets, such as and especially Treasury debt, it will pump money directly into markets, short circuiting the banking system and the string that temporarily kept inflation at bay. Both will set off a gale of inflationary forces. Up until this point, I must confess I've had a bit of faith in Ben Bernanke, especially considering the fact that I think the Fed should be abolished and fractional reserve banking outlawed, and the US dollar discontinued and replaced with gold. So I'm not likely to be the biggest fan a Fed chairman has ever had. Many people call him "Helicopter Ben," after comments he made during Senate hearings prior to his confirmation. I think a better name would be "Tricky Ben." The guy has managed to do unimaginable monetary summersaults with the money and banking system without setting off inflation, and, more importantly, without some of the smartest financial guys in the world realizing he wasn't actually doing much of anything at all. Everyone remembers the interest rate cutting campaign of 2007, when the rate fell from 5.25% all the way down to 1% (and now 0.0-0.25%). What almost every commentator failed to notice except Gary North (where I learned about it, and pretty much all the rest of what I know about Austrian theory. All credit for these observations goes to him) was that the Fed was not intervening in markets to achieve the rate cuts! This is clearly seen by the utterly flat AMB graph throughout 2007 and most of 2008. The failure of the AMB to rise implies that assets were not bought to induce the rate cuts. So "Tricky Ben" simply announced rate cuts, then did nothing to make them happen! They occured on a free and open market, which implies that natural rates were really already that low. Bernanke was simply saying what the market already knew to be true, and pretending that it was Fed policy. For almost a year, commentators talked about an easing monetary policy because they were all transfixed by the overnight rate, when in reality, Bernanke was being one of the greatest tightwads in Fed history. Next came the TAF program, in which Bernanke traded Treasuries held by the Fed for the bad debt held by banks. This helped keep banks solvent, at least on paper, again without increasing the money supply. Banks were propped up, while the AMB was unchanged. Then there was the TARP program, which finally sent the AMB to the moon. The Fed bought bank assets with freshly printed money, but then offered to pay interest on that money to hold it in its own vaults. Yet again, the Bernanke props up the banks, this time increasing the money supply, but without allowing that money to leak into markets and drive up prices. This is clearly visible in my previous post on the AMB. AMB skyrockets. M1, mostly flat. So, thus far, Bernanke has conducted a flying trapeez of a central banking policy without unleashing a whirlwind of inflation. Yet. But the actions mentioned here would cause all inflationary hell to break loose. I hope this is more jawing with the market, less action. I hope he doesn't actually intend to do this stuff. Many (OK almost ALL) observers are saying that with the CPI down, there is plenty of room for loose monetary policy without causing inflation. Many are welcoming this announcement with open arms. In fact, as we observed in my previous post, quite a few are worried about deflation. This, of course, is because they are Keynesians and don't know what inflation or deflation means. Little do they know they are embracing financial suicide. Prices are falling because Americans are finally, finally, accumulating savings and reducing the rate at which they take on new debt. Prices were inflated because people were spending beyond their means. They were induced to do this by insanely low, government-subsidized interest rates and the consequent monetary expansion of the 90's and early 2000's clearly visible on the AMB and M1 graphs. Rates rose, the monetary base stabilized, and now they have stopped taking on debt quite as readily, and cut back spending in favor of paying down debt and saving. This is not deflation. This is sanity returning to overstretched markets. This is a perfectly sensible, rational, healthy response to being overstretched and financially strapped in uncertain economic times. It is what our economy needs. We need the savings to make the investments that will be required to turn the economy around. Almost every commentator further agrees that one of the biggest problems with markets is excessive levels of debt. Now that that situation is reversing, they want to take precisely the policy that would induce the same irrational, debt-happy behavior that got us into this mess in the first place. These stupid Keynesians want to flog savers over the head for doing the right thing by inflating the currency right out from underneath them, withdrawing purchasing power from their accounts and spending it into the market for them to prop up prices at their boom levels. The boom busted because it was not sustainable. We don't need to return to it; we need to fix it. This is like having a fifth of Jack Daniels for breakfast because you have a hangover. It is not going to make things better, it is going to make things much, much worse down the road. Do not be fooled by the talk of deflation. Look at the GDP. We are in recession. GDP is falling. Production is falling. Look at the AMB. Look at M1. The money supply is rising. Production is falling, money supply is rising. This is inflationary. It is not too bad so far, but if Bernanke follows through with this, rest assured it will be. I hope, I pray, that Bernanke understands this. I hope he does not follow through with what he has stated today.

No comments:

Post a Comment