July 17, 2024

Fed Manipulating Markets In Zero Sum Game To Create Higher Inflation

Presidential hopeful Mitt Romney recently said that “You know, I’m not willing to light my hair on fire to try and get support. I am who I am.”  If only the Federal Reserve Chairman could be so restrained.  Based on recent comments from Fed Chairman Bernanke, it seems likely that he would gladly set both his hair and beard on fire in order to accomplish his mutually exclusive goals of increasing employment while maintaining price stability.

With a stubbornly high rate of unemployment, massive fiscal deficits, very slow economic growth, declining incomes and debt levels that are strangling the U.S. consumer, the Fed is facing a quandary.  How can economic growth be stimulated without simultaneously igniting inflation?

Lower interest rates, the most powerful tool in the Fed’s arsenal, has already been fully exploited while providing  a zero net benefit for consumers.  The zero sum game of lower rates did not prevent the housing market from crashing, has not helped it to recover and has resulted in dramatically reducing interest income for millions of consumers.  Every dollar of interest saved by one consumer means one less dollar of income for savers, many of them retirees who suddenly have seen their CD rates drop to near zero.

With rates at zero, the Fed is now forced to use the last resort option of QE, risking higher inflation as it stokes the economy with digitally created dollar bills.  Increased inflation is the high risk option that the Fed is willing to take as explained in  Bernanke Seen Accepting Faster Inflation as Fed Seeks to Boost Employment.

Federal Reserve Chairman Ben S. Bernanke spent six years pushing for an inflation goal. Now that he has it, some investors are betting he’ll breach the 2 percent target in the short run to lower unemployment.

“The chairman seemed to suggest they will tolerate a misdemeanor on inflation as unemployment continues to fall toward their goal” over several years, said Mark Spindel, chief investment officer at Potomac River Capital, a hedge fund that manages $250 million in Washington.

Policy makers at a March 13 meeting probably won’t deviate from their commitment to hold the main interest rate close to zero at least through late 2014, even if their forecast shows a burst of energy-driven inflation, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. They’ll probably be more concerned that rising prices will hold back real spending, impeding growth and improvement in the job market, he said.

Crude oil prices have risen 32 percent since the end of the third quarter of 2011 and 6 percent this year. Energy prices could hold the Federal Open Market Committee’s inflation target benchmark, the personal consumption expenditures price index, above the Fed’s 2 percent inflation objective for much of 2012, Crandall said. The PCE rose 2.4 percent for the 12 months ending in January.

Also, workers have weak leverage for increasing wages to compensate for higher costs. Real average weekly earnings have fallen for 10 consecutive months on a year-over-year basis. As energy costs eat up more of consumer expenditures, companies have difficulty raising prices on other goods and services.

“To the extent that PCE inflation is somewhere around 3 percent while unemployment is still above 8 percent, I think there will still be no reaction from the Fed,” said Worah, who’s based in Newport Beach, California.

The expectation among investors that the Fed will allow for a temporary overshoot on the price goal has been “unambiguously bullish” for Treasury Inflation-Protected Securities, Worah said.

Gold, up 18% over just the past year, is also telling us that the Fed is likely to shoot past its goal of attaining a 2% inflation rate.  Furthermore, the Fed’s goal of accepting increased inflation as an acceptable risk for increased economic growth is a self defeating zero sum game.  By driving up inflation, the Fed has increased living costs for the average consumer, negating any positive net affect from stronger economic growth. Consumers, whose spending makes up 70% of GDP, ultimately can’t spend more without real income growth.

In an interview with CNBC, Jim Grant of Grant’s Interest Rate Observer, and a frequent critic of destructive Federal Reserve monetary policies, says the Fed is manipulating interest rates for the sake of achieving “desirable macro outcomes”.  Discussing the Fed’s latest scheme to expand money printing, known as “sterilized bond-buying”, Grant says he is uncomfortable with the program which will create inflation and distortions that will destabilize the entire debt market.

Grant also feels that Bernanke, a self proclaimed “expert’ on the depression of the 1930’s is making fundamentally flawed decisions to forestall Depression II that many feel is looming in front of us.  According to Grant, Bernanke can’t “stop talking about the ’30s”, but when the economy fell off a cliff in 1920 – 1921, the government actually balanced the budget and the Fed raised interest rates and the economy soon recovered on its own and not due to running “immense deficits”.

The full interview with Grant is worth listening to. Please click on this link if the video below does not play.

The Fed has only one hand left to play and it will continue to print money, a fact that has not gone unrecognized by the gold and precious metals markets.

Why A Gold Backed Currency Is No Longer Possible

It is ironic that one of the most eloquent proponents of a gold standard did the most to ensure that we will never have one.  Alan Greenspan’s 1966 paper entitled “Gold and Economic Freedom” expounded on the role of a gold backed currency in protecting wealth against inflation by restricting the amount of money that could be produced.

Greenspan notes that the creation of the Federal Reserve was based on the premise that a central bank could supply increased reserves to banks when necessary and thereby offset natural turn downs in the business cycle.

“But the process of cure was misdiagnosed as the disease: if shortage of bank reserves was causing a business decline-argued economic interventionists-why not find a way of supplying increased reserves to the banks so they never need be short! If banks can continue to loan money indefinitely-it was claimed-there need never be any slumps in business. And so the Federal Reserve System was organized in 1913.”

It was not long before the Fed’s ability to allow unchecked credit expansion by banks laid the groundwork for the economic collapse know as the Great Depression.  Greenspan states that in an attempt to offset a mild business contraction in 1927, massive amounts of new bank reserves fostered a speculative boom ending with the Wall Street Crash of 1929.

“When business in the United States underwent a mild contraction in 1927, the Federal Reserve created more paper reserves in the hope of forestalling any possible bank reserve shortage… The excess credit which the Fed pumped into the economy spilled over into the stock market-triggering a fantastic speculative boom. Belatedly, Federal Reserve officials attempted to sop up the excess reserves and finally succeeded in braking the boom. But it was too late: by 1929 the speculative imbalances had become so overwhelming that the attempt precipitated a sharp retrenching and a consequent demoralizing of business confidence. As a result, the American economy collapsed. Great Britain fared even worse, and rather than absorb the full consequences of her previous folly, she abandoned the gold standard completely in 1931, tearing asunder what remained of the fabric of confidence and inducing a world-wide series of bank failures. The world economies plunged into the Great Depression of the 1930’s.”

Fast forward 75 years and we are looking at an eerily similar situation.  Unlimited credit creation by the Fed creates multiple asset bubbles that precipitate an economic crash and the dawn of Great Depression II.

Greenspan goes on to explain why there was ardent opposition to the gold standard despite the catastrophic results of unchecked  credit creation by the Fed in the 1920’s and why deficit spending is equivalent to the confiscation of wealth.

“But the opposition to the gold standard in any form-from a growing number of welfare-state advocates-was prompted by a much subtler insight: the realization that the gold standard is incompatible with chronic deficit spending (the hallmark of the welfare state).

In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold…The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.

This is the shabby secret of the welfare statists’ tirades against gold. Deficit spending is simply a scheme for the confiscation of wealth. Gold stands in the way of this insidious process. It stands as a protector of property rights.”

Ironically, the man who best understood the merits of a gold backed currency became the driving force behind the unlimited credit expansion that lead to the largest financial crisis in U.S. history.

Greenspan’s compromise of principles is beyond reproach for a man who understood the consequences of  ultra easy monetary policies, yet allowed himself to be corrupted by lobbyists, bankers and politicians.  Does anyone expect a better performance from current Fed Chairman Ben Bernanke, a man who blatantly prints money in an overt attempt to further debase the U.S. dollar?

Incredibly, Alan Greenspan disingenuously initiated another discussion on the need for a gold standard earlier this year.  In an interview with Fox News in January 2011,  Mr. Greenspan had the temerity to say:

“We have at this particular stage a fiat money which is essentially money printed by a government and it’s usually a central bank which is authorized to do so. Some mechanism has got to be in place that restricts the amount of money which is produced, either a gold standard or a currency board or something to that nature, because unless you do that, all of history suggest that inflation will take hold with very deleterious effects on economic activity.”


Three conclusions can be reached regarding a U.S. gold standard:

1.  Mr. Greenspan should cease talk about a U.S. gold standard and the dangers of unlimited credit expansion – his previous record  speaks for itself.

2.  The ability of the U.S. to adopt a gold backed currency has been overwhelmed by the debt and leverage which now threaten to bring on a deflationary collapse.  Ben Bernanke knows this which is why he has been printing money on an unprecedented scale.

Ironically, the creation of new credit may be the only factor preventing us from sliding into a deflationary depression  triggered by massive debt defaults.  Ben Bernanke’s prescription of inciting inflation and curing excessive debt with more debt may be the only poor policy option remaining to forestall an unimaginable economic nightmare.  With the global economy tottering on the edge of another financial crisis,  the adoption of a gold standard by the U.S. remains a very remote possibility.

3.  Since the government is not interesting in preserving the value of our currency, individual initiative becomes necessary.  Ten years of rising gold prices tells us the smart money is not waiting for a gold backed currency but instead is turning directly to gold.