The pie is now in the oven. The list of ingredients is not very appealing. There’s inflation. Devaluation of the dollar. A currency war. Recession? Depression? Anarchy? Civil unrest? ?????. No one can predict how far things can spiral downward if the economy really pulls back due to reckless policies. The last mystery ingredient is unknown because nobody can predict how this will ultimately play out.What we do know for sure is that the other ingredients are already baked in. By design. The cause of all of this is the Federal Reserve. Chairman Ben Bernanke just gave our economy a death sentence when he announced QE2. Quantitative Easing round two. The Fed is too late to the party. The Fed formulates policy based on previous results. They don’t look forward. They see the U.S. core inflation as being too low. Injecting half a trillion, or much more, into the economy is designed to purposely devalue the dollar. We are now trying to play catch-up with the other global players in a race to the bottom. China has been well ahead for quite some time. The intended result is the increased value of exports and the reduction of our foreign debt.
What has been happening is liquidity, or available capital, has been heading overseas in droves. What is perceived as a credit crunch has not been the case. The nations large banks and investment firms as well as big corporations have been sitting on their money and they need a place to park it. They have in excess of a trillion right now, why do they need more and what good would it do? They can make more money investing it short-term overseas. The blame for this strategy falls on Obama. These companies can’t see a clear path for taxation and regulation from the administration. Nothing is worse in the business world than the unknown. They aren’t lending and investing accordingly. They had access to all the liquidity they needed via QE1 after the financial meltdown of 2008. TARP and various other Fed programs injected trillions into the markets and now these companies aren’t conforming by re-investing.
In fact, it’s gotten to the point that other countries around the globe are imposing capital controls because they simply can’t absorb it all. Basically, it falls back to basic supply and demand. The U.S. economy doesn’t have the demand required to attract that investment liquidity. The Fed intends to artificially provide it. It always fails. Like an untested drug, there are side effects, usually unintended. These are the pie ingredients.
Since the U.S. dollar is the world’s reserve currency, anything the Fed does has worldwide ramifications. Devaluing the dollar here at home will affect all of those countries who have their currencies pegged to it. We’re playing with fire in a cat and mouse game to control imports and exports and the value of the debt. The risks are extremely high. One of the reasons that I have discussed in other posts in the mandate placed upon the Fed by Congress to attempt to create full employment here at home. This is what causes Fed policy to go astray. For example, the desire to devalue the dollar will lead to our exports costing other countries less. This should increase demand leading to domestic companies fulfilling that demand by expanding and hiring more workers. The downside is that the other countries exports cost us more so we import less. This causes an unnatural trade imbalance. For those countries that import more from us than they export, it’s a terrible situation causing economic problems in their countries. Obama is currently in one of them. India imports 60% of their food commodities. The Fed QE2 policy will directly result in higher food prices for them.
Brazil, Japan, South Korea are just a few examples in which we are likely to see currency wars. They don’t have any desire to bear the burden of higher costs in order to prop up the U.S. domestic economy. At present, the Fed plans to purchase $75 billion in bonds each month. That’s funny money to you and me. They just turn on the printer and create it out of thin air. This isn’t what actually happens. It’s all done in cyberspace. A few clicks of the computer and the Fed provided money shows up on the balance sheet at the Treasury. They then have the authority to coin the money and make it available to the Federal Reserve banks. This is then made available to your local banks as credit.
Domestically, QE2 is designed to lower interest rates. This should translate into increased consumer spending. Mortgages, cars, whatever. It’s no coincidence that Christmas is around the corner. The Fed wants you to take advantage of the lower costs of credit and purchase items. The key is credit. The cost of goods are rising, but when you buy on credit with that great low rate, you tend to overlook the actual cost of the product. All of this buying should lead to more demand and the corresponding hiring of more workers to meet it. Again, part of the Fed mandate for full employment.
It all sounds pretty good so far, doesn’t it? Not so fast. The dark side is particularly ugly. When you devalue the dollar, you have created inflation. The dollar in your wallet is now worth less. That’s what $75 billion instantly added to the money supply not backed by anything does. Each and every month the Fed pursues this policy, that will be the result. You have instant price inflation as your dollar now buys less. It’s already started. Oil is up 18% since May. Meat is up 20% this year. All commodity prices will now rise. This means your food, your gas, your utilities plus any product made from raw materials. Doesn’t leave out much, does it?
What will we see right away? The dollar will plummet. Foreign currencies will rise in value. Commodities will really take off in value. Interest rates will drop even further. Every time you think Freddie Mac can’t possibly lower their rates anymore, they do. If you’ve stubbornly put off that re-financing, this is really the time. The new round of lower rates should take us down to the floor. Miss this round and you may regret it for many, many years. Once hyper-inflation kicks in, double-digit interest rates ala the 1980’s will make a return. That will be the death of the housing market including refinancing. Gold will continue its march into new record territory. It’s always the primary hedge against inflation. The stock market will like it. Company profits will initially rise and you’ll see it reflected in the markets.
What short memories we have. The last time we had Fed induced inflation in 2003-2004, the result was the inflating of the housing bubble. We all know where that lead to. Now we’ll see new bubbles forming. It won’t take several years for the collapse, however. This time around, the global players are in the mix and their reactions won’t allow it to fester. We can only hope that they take bold enough actions in short order so that the Fed will have to back down. By the way, all the while that this will be playing out, the Fed will be making money hand over fist on the interest it charges the Federal Reserve banks for QE2. Remember, they are beholden to their private shareholders to make money and they will do so at the expense of the U.S. taxpayer.
2011 is shaping up to be a disaster. We face the largest tax hike in our history if Congress doesn’t extend the Bush tax cuts. We’re already seeing that our health care premiums are going to skyrocket next year. We’ll have the costs of inflation to bear. The commodity prices that will force food and gas to jump. The unemployment rate is still way high. We just had a month in which over 150,000 private sector jobs were created and that still couldn’t bring down the unemployment rate. Millions of foreclosures still have to make their way through the markets keeping housing prices depressed. What rational person can see this path as the correct one to take?
As I said before, the Fed operates looking backward. They make decisions going forward on statistics that only show up as lagging indicators. It would be helpful if they were free of the full employment mandate. They also serve as the lender of last resort. This is to fulfill their other mandate of providing market stability. They fail at this as well, however. Their toolbox consists primarily of methods to artificially manipulate the markets and the money supply. In other words, printing money and setting interest rates. The direct result is our continuous cycle of boom/bust economics. When your measurement tools are looking backward by design, it is virtually impossible to know when to expand or contract liquidity and to raise or lower the interest rates. They are always behind the eight ball.
There is some reason for hope. Ron Paul is about to be named to head the Congressional sub-committee to oversee the Fed’s actions. While he failed in his attempt to audit the Fed, he will now have an inside track to doing so. He was blunted the last two years by Barney Frank and Chris Dodd from making any in-roads into what really goes on at the Fed. Perhaps this is another reason Bernanke decided to implement QE2 now when most economists think it’s no longer practical or necessary. Should Ron Paul garner enough support, he could drastically change the way business is conducted at the Fed. We still have the lame duck session of Congress to play out, so it will be some time before Paul could even begin the process. Bernanke is also very good at stalling and could still buy enough time to ensure yet another fantastic payday for his cronies.
What is needed is to de-centralize that much power. Stability of the banking sector is of paramount importance. So is credit in times of instability. So is employment obviously. And so on. Why we would condone centralizing that much power and authority in an agency that is unaccountable is foolish. Breaking up the Fed and distributing its necessary functions amongst smaller and separate entities would eliminate this. The original intent was stated to keep the Fed neutral and free of the political influence of the parties. Yet they simply serve a different master. They publicly report shareholder profits from its lending operations. Without regular audits, we have only their word to know if this is accurate. And it’s what goes out the back door unaccounted for that is of greater concern.