By upping the ante once again in its
gamble to revive the lethargic economy through monetary action, the Federal
Reserve's Open Market Committee is now compelling the rest of us to buy into
a game that we may not be able to afford. At his press conference this week,
Fed Chairman Bernanke explained how the easiest policy stance in Fed history
has just gotten that much easier. First it gave us zero interest rates, then
QEs I and II, Operation Twist, and finally "unlimited" QE3.
Now that those moves have failed to
deliver economic health, the Fed has doubled the size of its open-ended money
printing and has announced a program of data flexibility that virtually
insures that they will never bump into limitations, until it's too late.
Although their new policies will create numerous long-term challenges for the
economy, the biggest near-term challenge for the Fed will be how to keep the
momentum going by upping the ante even higher their next meeting.
The big news is that the Fed is now
doubling the amount of money it is printing. In addition to its ongoing $40
billion per month of mortgage backed securities (to stimulate housing), it
will now buy $45 billion per month of Treasury debt. The latter program
replaces Operation Twist, which had used proceeds from the sales of
short-term treasuries to finance the purchase of longer yielding paper. The
problem is the Fed has already blown through its short-term inventory, so the
new buying will be pure balance sheet expansion.
To cloak these shockingly accommodative
moves in the garb of moderation, the Fed announced that future policy
decisions will be put on automatic pilot by pegging liquidity withdrawal to
two sets of economic data. By committing to tightening policy if either
unemployment falls below 6.5% or if inflation goes higher than 2.5%, Bernanke
is likely looking to silence fears that the Fed will stay too loose for too
long. While these statistical benchmarks would be too accommodative even if
they were rigidly enforced, the goalposts have been specifically designed to
be completely movable, and hence essentially meaningless.
Bernanke said that in order to identify
signs of true economic health, the Fed will discount unemployment declines
that result from diminishing labor participation rates. It is widely known
that a good portion of unemployment declines since 2009 have resulted from
the many millions of formerly employed Americans who have dropped out of the
workforce. But like many other economists, Bernanke failed to identify where
he thinks "real" employment is now after factoring out these
workers. So how far down will the unemployment number have to drift before
the Fed's triggering mechanism is tripped? No one knows, and that is exactly
how the Fed wants it.
A similarly loose criterion exists for
the Fed's other goalpost - inflation. Bernanke stated that he will look past
current inflation statistics and look primarily at "core inflation
expectations." In other words, he is not interested in data that can be
demonstrably shown but on much more amorphous forecasts of other economists
who have drunk the Fed's Kool-Aid. He also made clear that rising food or
energy prices will never fall into the Fed's radar screen of inflation
For as long as I can remember (and I can
remember for quite some time) the Fed has stripped out "volatile"
increases in food and energy, preferring the "core" inflation
readings. But in the overwhelming majority of cases, the headline numbers are
significantly higher than the core. In other words, Bernanke simply prefers
to look at lower numbers. In his press conference, he made it clear that the
Fed will avoid looking at price changes in "globally traded
commodities," that are all highly influenced by inflation.
These subjective and attenuated criteria
give Fed officials far too much leeway to ignore the guidelines that they are
putting into place. If the Fed will not react to what inflation is, but
rather to what it expects it to be, what will happen if their expectations
turn out to be wrong? After all, their track record in forecasting the events
of the last decade has been anything but stellar.
The Fed officials repeatedly assured us
that there was no housing bubble, even after it burst. Then they assured us
the problem was contained to subprime mortgages. Then they assured us that a
slowdown in housing would not impact the broader economy. I could go on, but
my point is if the Fed is as spectacularly wrong about inflation as it has been
about almost everything else, will they be able to slam on the brakes in time
to prevent inflation from running out of control? And if so, at what cost to
the overall economy?
The Fed is committing to more than a $1
trillion annual expansion in its balance sheet, an amount greater than the
total size of its balance sheet as late as 2008. Most forecasters believe
that the Fed will have $4 trillion worth of assets on its books by the end of
2013, and perhaps more than $5 trillion by the end of 2014. If conditions
arise that require the Fed to withdraw liquidity, the size of the sales that
would be required will be massive. Who exactly does the Fed believe will have
pockets deep enough to take the other side of the trade?
As the biggest buyer of treasuries, it
is impossible for the Fed to sell without chances of collapsing the market.
Surely any other holders of treasuries would want to front-run the Fed, and
what buyer would be foolish enough to get in front of the Fed freight train?
The bottom line is that it is impossible for the Fed to fight inflation,
which is precisely why it will never acknowledge the existence of any
inflation to fight.
But perhaps the most absurd statement in
Bernanke's press conference was his contention that the Fed is not engaged in
debt monetization because it intends to sell the debt once the economy
improves. This is like a thief claiming that he is not stealing your car,
because he intends to return it when he no longer needs it. To make the
analogy more accurate, there could not be any other cars on the road for him
Without the Fed's buying, it would be
impossible for the Treasury to finances its debts at rates it can afford.
That is precisely why the Fed has chosen to monetize the debt. Of course,
officially acknowledging that fact would make the Fed's job that much harder.
Without the monetization safety valve, the government would have to make
massive immediate cuts in all entitlements and national defense, plus big tax
increases on the middle class.
As I wrote when the Fed first embarked
on this ill-fated journey, it has no exit strategy. The Fed adopted what
amounts to "the roach motel" of monetary policy. If the Fed
actually raised rates as a result of one of its movable goal posts being hit,
the result could be a much greater financial crisis than the one we lived
through in 2008. The bond bubble would burst, interest rates and unemployment
would soar, housing prices would collapse, banks would fail, borrowers would
default, budget deficits would swell, and there would be no way to finance
another round of bailouts for anyone, including the Federal Government
In order to generate phony economic
growth and to "pay" our country's debts in the most dishonest
manner possible, the Federal Reserve is 100% committed to the destruction of
the dollar. Anyone with wealth in the U.S. dollar should be concerned that
economic leadership is firmly in the hands of irresponsible bureaucrats who
are committed to an ivory tower version of reality that bears no resemblance
to the world as it really is.
Peter Schiff is the CEO and Chief Global
Strategist of Euro Pacific Capital, best-selling author and host of
syndicated Peter Schiff Show.
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