This week, national attention was fixated on JetBlue
flight attendant Steven Slater, whose bold, creative, and controversial exit
strategy could revitalize his future prospects. Not nearly as noticed was the
Federal Reserve’s decision on Tuesday to avoid finding an exit strategy
for its own never-ending career trap. Unfortunately, the Fed’s choices
affect our lives much more than Slater’s.
Just a few weeks ago, pundits were asking how Ben
Bernanke would shrink the Fed’s bloated post-crisis balance sheet. But
in its August 10th decision, the Fed signaled that it would
“recycle” its debt holdings; in other words, there would be no
exit strategy for the foreseeable future. Given the fact that monetary
stimulus will not only fail to spark a genuine recovery, but create a
never-ending need for successively larger doses, Bernanke should grab a few
beers and head for the nearest available emergency slide.
About a year ago, economic forecasters claiming insight
into Fed deliberations spread the word that the central bank had devised a
methodical exit strategy to unwind its balance sheet. The only question
they thought worth discussing was when the plan would begin. Some even
speculated that it already secretly had. In a July 2009 commentary
entitled “No Exit for Ben,” I argued that
Bernanke and his cohorts never had any serious intention of implementing such
a policy. I suggested that the Fed would continue to play the role of
money-pusher– making sure the addicts were never denied a fix, even if
an overdose threatened.
Like their patrons in the White House and on Capitol
Hill, the Fed is totally dedicated to postponing the short-term consequences
that would result from breaking America’s addiction to cheap money and
easy credit. Compared to this imperative, the long-term economic health of
the country barely gets a second thought.
Any moves by the Fed to shrink its balance sheet,
thereby withdrawing liquidity from the real estate market, would add
significant downward pressure to home prices. Lower house prices would
bring on an additional wave of foreclosures, which would then force many
previously bailed-out financial institutions back into bankruptcy. (With
foreclosure data growing more ominous despite the current stability in house
prices, it looks like these institutions are headed back toward bankruptcy
even with Fed support.)
To prevent this economic chain-reaction, the Fed will
step in with “quantitative easing” as soon as it becomes obvious
that the Administration’s stimulus-fueled “recovery” of the
past three quarters is fading. The problem is that each round of stimulus, as
with each hit of an addictive drug, requires ever larger doses to produce the
same result. The more leveraged an economy becomes, the bigger the lever
required to move it. So the more the Fed stimulates now, the more it
will be forced to stimulate later. The only exit strategy this course allows
is an overdose– hyperinflation.
To counter these concerns, Bernanke and his supporters
have said that their stimulus will be withdrawn as soon as the recovery takes
hold in earnest. This misses the point that any “growth” created
by stimulus is totally dependent on stimulus to continue. The
“recovery” will end as soon as the stimulus prop is
removed.
Those who fear a double dip recession are justified in
their concerns, but they are also missing the big picture. The 2008
recession never ended. It was merely interrupted by trillions of dollars of
stimulus that purchased GDP “growth” with borrowed
money. But as the bills come due, GDP should now contract so we can
settle up– but instead we’ll take on more debt.
I expect the coming doses of quantitative easing will
finally spark adverse reactions, first in the dollar and later in the bond
market. When a falling dollar forces consumer prices and long-term
interest rates to rise, the Fed’s actions will be rendered impotent.
The Open Markets Committee will have to make a horrific choice: fight
inflation by tightening policy into a weakening economy, or fight recession
by allowing inflation to burn out of control. I think it’s obvious that
they will choose inflation, all the while pretending that it doesn’t
exist.
Unfortunately, no one at the Fed has the honesty and
courage to suffer the short-term shock that would accompany any meaningful
exit strategy. Withdrawing liquidity and shrinking the Fed’s bloated
balance sheet would no doubt bring on a severe contraction in GDP, but the
moves would also enable the US economy to form a solid foundation of savings,
capital investment, and industrial production upon which a real recovery
could be built. By contrast, more stimulus simply magnifies the imbalances,
including excessive government spending, too much consumption, inadequate
production, and artificially elevated asset prices. After decades of abuse,
it’s time for the Fed to take make a dramatic exit, because the US
economy can’t take it anymore.
Peter D. Schiff
President/Chief Global Strategist
Euro Pacific Capital, Inc.
20271 Acacia Street, #200 Newport Beach, CA 92660
Toll-free: 888-377-3722 / Direct: 203-972-9300 Fax: 949-863-7100
www.europac.net
pschiff@europac.net
For a more in depth analysis of the tenuous
position of the American economy, the housing and mortgage markets, and U.S.
dollar denominated investments, read my new book : The Little Book of Bull Moves in Bear Markets" (Wiley,
2008).
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