Posted on 08/12/2011 9:33:33 PM PDT by sickoflibs
This week's wild actions on Wall Street should serve as a stark reminder that few investors have any clue as to what is really going on beneath the surface of America's troubled economy. But this week did bring startling clarity on at least one front. In its August policy statement the Federal Reserve took the highly unusual step of putting a specific time frame for the continuation of its near zero interest rate policy.
Moving past the previously uncertain pronouncements that they would "keep interest rates low for an extended period," the Fed now tells us that rates will not budge from rock bottom for at least two years. Although the markets rallied on the news (at least for a few minutes) in reality the policy will inflict untold harm on the U.S. economy. The move was so dangerous and misguided that three members of the Fed's Open Market Committee actually voted against it. This level of dissent within the Fed hasn't been seen for years.
Many economists have short-sightedly concluded that ultra low interest rates are a sure fire way to spur economic growth. The easier and cheaper it is to borrow, they argue, the more likely business and consumers are to spend. And because spending spurs growth, in their calculation, low rates are always good. But, as is typical, they have it backwards.
I believe that ultra-low interest rates are among the biggest impediments currently preventing genuine economic growth in the US economy. By committing to keep them near zero for the next two years, the Fed has actually lengthened the time Americans will now have to wait before a real recovery begins. Low rates are the root cause of the misallocation of resources that define the modern American economy. As a direct result, Americans borrow, consume, and speculate too much, while we save, produce, and invest too little.
It may come as a shock to some, but just like everything else in a free market, interest rate levels are best determined by the freely interacting forces of supply and demand. In the case of interest rates, the determinative factors should be the supply of savings available to lend and the demand for money by people and business who want to borrow. Many of the beneficial elements of market determined rates are explained in my book How an Economy Grows and Why it Crashes. But allowing the government to determine interest rates as a matter of policy creates a number of distortions.
It was bad enough that the Fed held rates far too low, but at least a fig leaf of uncertainty kept the most brazen speculators in partial paralysis. But by specifically telegraphing policy, the Fed has now given cover to the most parasitic elements of the financial sector to undertake transactions that offer no economic benefit to the nation. Specifically, it will simply encourage banks to borrow money at zero percent from the Fed, and then use significant leverage to buy low yielding treasuries at 2 to 4 percent. The result is a banker's dream: guaranteed low risk profit. In other words it will encourage banks to lend to the government, which already borrows too much, and not lend to private borrowers, whose activity could actually benefit the economy.
This reckless policy, designed to facilitate government spending and appease Wall Street financiers, will continue to starve Main Street of the capital it needs to make real productivity-enhancing investments. American investment capital will continue to flow abroad, denying local business the means to expand and hire. It also destroys interest rates paid to holders of bank savings deposits which traditionally had been a financial pillar of retirees. In addition, such an inflationary policy drives real wages lower, robbing Americans of their purchasing power. The consequence is a dollar in free-fall, dragging down with it the standard of living of average Americans.
Until interest rates are allowed to rise to appropriate levels, more resources will be misallocated, additional jobs will be lost, government spending and deficits will continue to grow, the dollar will keep falling, consumer prices will keep rising, and the government will keep blaming our problems on external factors beyond its control. As the old adage goes, "insanity is doing the same thing over and over again and expecting different results."
I guess they don’t teach the Plunge Protection Team in College.
Dumb people and smart people alike can actually watch this “miracle” occur during the final hours of trading on any bad day. It’s a true miracle!
I get it. You’re not a Peter Schiff fan.
They are not. Much of that “cash” is actually credit they do not want to spend.
And they are wise.
This is a debt-based depression, not an inventory recession.
Too much debt is the core of the problem.
For the cash that businesses are holding on to, they are very wise to do so. The lack of income from high unemployment, low consumer spending, and insane governmental fiscal policy will provide business with a cash buffer that they can use to stay in business and pay workers when income drops.
Costs for businesses are already on the rise. They have absorbed this extra cost (margin compression) to a great degree until now. But now they have no choice but to pass it on to the consumer (inflation), as WalMart has stated recently. Having some savings enables them to do this, and that has helped the economy.
An entity that produces without consuming, ie saves or hordes the vehicle of trade, is a net plus to an economy (if there is a non manipulated market).
Those numbers are bogus. And the 400-point surge was no more due to retail sales than the 500-point decline was due to the revision of the unemployment claims ticking last month back over the 400K handle.
“Retail spending” was up because cost was up, not because people are buying more stuff. Also, that increase was covered by increased use of credit cards, which has occurred because increase in pay has not risen to keep pace with rising costs.
This is a very bad sign, because up to this point, people were actually lowering personal debt, which indicates that they are aware of the debt problem. That they are aware of the debt problem and yet have reverted to taking on credit-card debt is an alarming trend, as it indicates that those who were just getting by after having made budgetary adjustments are no longer getting by.
This trend will continue as producers are forced to pass their increased cost along to the consumer, which they had been absorbing (margin compression) for as long as they could.
Also, if you see increased consumer spending (which I suspect we will) be very careful and, before you get too happy, check the rate of mortgage defaults. The recent trend in certain parts of the country where defaults are ahead of the curve, is that consumer spending is increasing. That is because people simply stop paying their mortgages and then find themselves with a couple of extra thousand dollars a month. This is what they’ve been spending. Hardly a good sign of the economy.
And if you want to use the GDP figure, government spending represents 1/3 of GDP. With all the increases in government spending over the past three years, 10-12% of GDP has been completely artificial based upon government spending. Remove that, and you are in depression territory. But it is worse than that, because that money used for spending was borrowed, so we are going to have to pay interest on that spending, and that money will come from the private sector.
Thanks for the ping!
Money quote:
Americans borrow, consume, and speculate too much, while we save, produce, and invest too little.
Isn’t it just absurd that they think that lowering the interest rates boosts lending and thereby boosts the economy, when all the lending is going back to the government and not the private sector? Are they that short-sighted and naive?
The GDP equation was designed specifically to illustrate Keynesian theory. You'll notice that there is no mention of business-to-business spending; the Keynesians consider production to be secondary to consumption.
In reality, consumer spending is about 1/3 of the economy. Business spending makes up the other third. Now, when business spending declines, GDP can't show it. The GDP merely shows an incomprehensible decline in consumer spending (which is understandable given job losses) which the Keynesians insist must be made up for by government.
But where does this spending come from? It either is drawn out of saved capital or is a result of money-printing. Both are bad for the economy.
Just remember that you can't consume until you've produced something to trade or sell. This is why we're in such a mess. The government continues to try and spur consumption when it should be encouraging production.
Of course, when you're anti-business to begin with, it all makes perfect sense.
Good luck with that. I think the best we can hope for is gov't staying mostly out of the way and not changing the rules on a seemingly daily basis.
“Just remember that you can’t consume until you’ve produced something to trade or sell. This is why we’re in such a mess.”
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It really is amazing how some of the most obvious facts are so easy for people to forget. Many actually believe that consumption is what drives an economy. I have always known better, having grown up on a tiny farm where from an early age I had to take a hand however tiny in producing what we ate. In spite of that I have to keep reminding myself that it is production, not consumption that it is all about. If it were about consumption as some believe then we would merely need to bring in an army of illegal immigrants to consume and the economy would thrive. Oh, wait, that IS what they believe, we are in real trouble.
Thanks for the reply.
” It boggles the mind how many people lack critical thinking skills and common sense. “
It just keeps getting worse....: )
>>>>...interest rate levels are best determined by the freely interacting forces of supply and demand.
you mean commissar beranke should be setting interest rates?
/s
...Deliberate genocide of the Republic and the middle class by the Potus and Congress...
Yesterday afternoon I took my granddaughter back to school shopping. We were at the Camarillo Premium Outlet Mall. The parking lot and stores were deserted. I even asked a clerk in Saks.....are you guys closing?
I have shopped there for many years and have never seen it even close to what it was yesterday. Was kind of eery
Consumer spending is 1/3, business spending is 1/3, so the other 1/3 is unknown spending? Just trying to understand.
Thank you for the detailed explanation. While this may not be a inventory recession in the technical sense, I have been observing the people around me and was coming to the conclusion that many already have too much “stuff” and with the current uncertainty have decided to forego buying more “stuff”. Also, some things are lasting a lot longer.
For example I had a 1986 Dodge Caravan. I had heard and sadly experienced that around 100,000 miles systems would start to fail. My current 1996 Caravan just crossed the 100,000 mark, and I am told many are doing well to 200,000. Pause to knock on wood. OK, I’m back. Since as a retired person I only drive about 3,000 miles a year, it will probably die of old age and salt rust before I need a new one. Thus I will avoid buying a new car for quite some time, hopefully for me if not the economy.
I didn’t mean to imply that there is no inventory recession. There is. But there are two principle types of recessions, inventory and credit/debt. The recessions we have seen for the past 75 years or so have been inventory recessions. These are caused by the central bank artificially manipulating the interest rate of loans, which sends signals to the markets. When the interest rates drop, money is cheap and easy and there is a lot of it. People misread this as being a sign that the economy is booming. People borrow thinking there is an increase in consumer demand when there is not. They hire workers, increase production, and then watch their output accumulate as there is no market to purchase the goods. They then have to reduce their headcount and sell at a reduced profit (or loss). These are the mild types of recessions.
The last time we saw a major debt-based recession was the 1930’s.
Unfortunately, debt-based recessions also cause inventory recessions. That is why unemployment is NOT a lagging indicator of this “recession” as many economists inaccurately claim. That is true in an inventory-based recession, as the last thing to happen is that companies re-hire after they’ve cleared out their inventory. In a debt-based recession, unemployment is a leading indicator. Businesses are letting people go as they try to adjust to the credit expansion and the debt overload. Those unemployed then stop purchasing which causes further contractions in the economy, which leads to further unemployment.
We are experiencing both types of recession at the moment, and it is only going to get worse. Much worse. Because we have not cleared the debt saturation and bad loans out of the economy.
I’ve had my tag for quite some time. I advise that everyone prepare for very hard times.
As I’ve been saying, we are at the brink of a global economic depression that will make the 1930’s look like the Roarin’ 20’s.
Now, an administration that CUTS the regs...like allowing more drilling for example...well, that's when we will see a boom again.
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