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With its
announcement this week that it will keep interest rates near zero until at
least late 2014, the Federal Reserve has put another large crack into the
foundations underlying the US dollar. In a misguided attempt to provide
clarity and transparency, Ben Bernanke has instead laid out a simple road map
for economists and investors to follow. The signposts are easily understood:
the Fed will stop at nothing in pursuing its goals of creating phantom GDP
growth, holding down unemployment, propping up stock and housing prices, and
monetizing government debt. To do so, it will continue to pursue a policy of
negative interest rates, while ignoring the collateral damage of
unsustainable debt, virulent inflation, misallocated resources and credit,
suffering yield-dependent retirees, and a devalued U.S. currency.
Not
surprisingly, precious metals and foreign currencies rallied strongly on the
news - with gold up more than 4.3% and the Dollar Index down nearly 1.6% in
the days following the announcement. The Dollar Index is now down more than
3.5% from its highs in mid-January.
In coming to
the momentous decision to extend the Fed's prior low-rate promises by another
18 months, Bernanke and his cohorts relied on a somber view of the economy
that is at odds with the sunnier view presented the night before by President
Obama in his State of the Union address. To justify holding rates so low for
so long, the Fed is choosing to ignore the fact that CPI inflation is
currently running north of 3%. Instead, it has conveniently chosen to look at
a hand-picked alternative measure, the chain-weighted core PCE, which comes
in just a shade below the Fed's arbitrary 2% target. How convenient.
After some
changes in key membership at the Federal Reserve's policy-setting Open
Markets Committee, in which a few long-time hawks were put out to pasture,
the Fed has now established itself at the extreme dovish end of the policy
spectrum. Among other central banks around the world, it may now be
outflanked only by some very profligate ones in South America and sub-Saharan
Africa. Unfortunately, the FOMC has its hands on the wheel of the world's
reserve currency, and therefore its decisions may lead the planet into
financial chaos as long as other nations are content to follow the Fed
farther and farther into a swamp of liquidity. To paraphrase Pete Seeger's
protest of the escalation of the war in Vietnam, "we are waist deep in
the Big Muddy and the damn fool yells 'press on.'"
The only
bright side of the announcement is that it provides precious-metal and
foreign-equity investors a fairly good sense that they are on the right side
of history. In order to keep rates low, especially at the long end of the
yield curve where it matters most, the Fed must continually print money to
buy U.S. Treasuries. This will likely push more investors into gold and away
from dollar-denominated assets.
As a
testament to their own faith in themselves to forecast economic conditions, 6
of the 17 voting FOMC members indicated that they would have preferred to
keep rates close to zero at least through 2015. Some even had the audacity to
prefer no change until 2016! This comes from the body that couldn't predict
the 2008 financial crisis, even while it stared at them from point-blank
range. To look into a completely uncertain future and determine that negative
interest rates can persist for another four years without igniting inflation
is to me the height of economic insanity. Sadly, the inmates have the keys to
the institution.
The lunacy
persists in the rest of the government as well, with Congress and the White
House still failing to address our nation's long-term debt issues. The Fed's
commitment gives these politicians a "Get Out of Jail Free" card to
continue avoiding responsibility. The deficits will be monetized, so no real
efforts need be made to cut spending or raise taxes on middle-class
Americans. Central to these plans is the assumption that the rest of the
world will happily park their savings in U.S. dollars forever. If the latest
announcement does not disabuse the world of this notion, I don't know what
will.
As long as
interest rates remain far below the rate of inflation, the U.S. economy will
fail to equitably restructure itself for a lasting recovery. As a secondary
effect, U.S. savers will likely continue to suffer from a lack of yield and a
weakening currency. In the end, the collapse of the U.S. economy will be that
much more spectacular due to the great lengths we have gone to postpone it.
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