The Fix Is In (Peter Schiff Explains why it will fail again)

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."

Thanks for explaining the difference. Regarding “money is cheap....People misread this as being a sign that the economy is booming.” I don’t think that is the case this time. I’m sure there are many like me who are paying down their HELOCs at 3.25% as fast as they can. However, unlike many, most of my equity is in rentable real estate (neglected for 10 years while caring for dying relatives), to which I am also alocating funds for reparing and improving. Fortunately, I live in an area were moderate to lowish income rentals will always be wanted. If it really hits the fan, I can always lower the rents.

Meanwhile, I have been working on an idea that might help. Experts have said that one of the problems now is that with all the lay-offs, downsizing, etc. that there are many inefficiencies regarding new hiring and unemployment. This plan would tackle that issue head on. If you would like to know more, private message me. I need an incentive to get transferring, updating, and computerizing what I have written the old fashioned way. An interested, knowledgeable, and friendly audience and critic would add motivation. I can send a summary and if you are still interested more as I put it in Open Office.

The GDP equation was designed specifically to illustrate Keynesian ~~theory~~ fantasy.

Putting the 'G' into the equation was a stroke of evil genius. Until you hit a debt ceiling, the government can hit whatever GDP number they want by spending more or less. And if the money being spent is borrowed, it isn't counted as a penalty.

We could have a great GDP if we just got China to pay for everything.

The currency supply is still over-inflated from the credit bubble caused all through the 90’s (tech bubble) and the early 00’s (housing bubble). That needs to be shaken out of the economy (and all the over-leveraged prices of assets which is a result of that excess credit). PM on the way.

Thanks sickoflibs.

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... rates will not budge from rock bottom for at least two years.

It's a method of propping up the stock market values, and a plum to mortgage seekers, but it undermines (continues to undermine) capital formation.

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