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Economic Optimism: Reading Between The Lines

October 20th, 2009

In the mainstream media, we are peppered with optimistic economic forecasts and reports of any positive changes in leading indicators.  For example suggestions that the U.S. economy is on pace to grow at an annualized rate of 2% or 3% during Q4-2009. This is reported as an “annualized” rate in order to hide the massive contractions[1] of Q1 (-8.6%) and Q2 (-2.3%).

Curiously though, even as the Federal Reserve continues to sustain the Zombieconomy by massive injections of liquidity and/or monetization, The Chairman insists that “The United States must increase its national savings rate.”[2]

I say “curiously” because, if this insistence is meant for the American people at large (i.e., he is urging Americans in the individual capacities to save money and/or pay down outstanding debt), this is at odds with the FOMC’s decision to keep nominal interest rates at or near zero per cent.  All else equal, higher interest rates encourage savings, and lower interest rates encourage debt. When the nominal interest rates are nil, and real inflation is rampant, there is little incentive to save money (other than the precautionary motive, a classic “leakage”), and it is savings in the form of investments that spur real economic growth.

As a matter of policy, if Bernanke wants to reduce or slow the growth of the national debt, he simply needs to put the brakes on the processes which enable the Treasury to sell (i.e., increase) the national debt. The Fed would need to stop buying debt, sovereign or otherwise, and the adjustment and restructuring would probably be quite painful, but hopefully short-lived.

Federal Reserve Balance Sheet

But actions speak louder than words ever do, and since the beginning of the year, the Fed has increased its holding of mortgage-backed securities 100-fold [3]—becoming literally the only player in the market. Reining in the national debt will prove exceedingly difficult as long as the FOMC attempts to maintain a Fed Funds rate target of approximately zero (0-25bp) “for an extended period” in order to “boost a week recovery that has yet to create jobs.”[2]

Not only has the “recovery” failed to produce jobs, the unemployment rate has practically doubled in the last year. Consumer prices show no threat of inflation [4] because jobs are being destroyed which means people are cutting back.  Meanwhile, those of us still punching the clock every morning are trying to pay down existing debts.  Taken as a whole, there is less present demand for consumption which keeps prices from rising in the short-run.

Unfortunately the only way the Fed can maintain interest rates at historic lows is to continually increase the money supply, which is inflation by the classical definition of the word. Whenever all that new money makes its way off of the banks’ balance sheets and into the rest of the economy in the form of credit, the inevitable consequence will be rising prices, or “inflation” in newspeak.

Notes:

  1. GROSS DOMESTIC PRODUCT: SECOND QUARTER 2009 (THIRD ESTIMATE) (BEA) The numbers for Q3 are not available until October 29
  2. Bernanke Says U.S., Asia Should Reduce Distortions (Bloomberg)
  3. A Look Inside Fed’s Balance Sheet — 10/07/09 Update (WSJ)
  4. Fed on Hold as U.S. Consumer Prices Show No Threat of Inflation (Bloomberg)

no third solution

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