The Fed Will Spend Trillions More
Signs Say Fed to Restart QE
There is no shortage of opinions out there on the current state of the economy. Even Federal Reserve officials are sending mixed signals these days.
The unemployment rate has dropped to 5.6% — the best Americans have seen since the fall of 2008.
But last week’s job numbers also showed a $0.05-an-hour drop in hourly wages. Wages rose just 1.7% in 2014, not even keeping up with inflation.
From an economics standpoint, this actually makes sense. If there is too much supply — in this case, people who are unemployed — then the way to clear the market is for prices to drop.
In this case, the prices are wages. It is certainly better for most people to be working at a slightly lower wage than to not be working at all.
This was one of the many problems during the Great Depression, as the government tried to prevent wages from dropping. This prevented a clearing of the market and led to high, sustained unemployment.
So while lower unemployment is good news overall, it has come at the expense of wages, which have been stagnant at best.
The other concern is that the extremely loose monetary policy of the last six years has created something of a false prosperity. We have to wonder how many of the newly created jobs are misallocated resources that will have to be corrected in the near future.
We are already seeing this play out in the oil markets. While supply and demand is an important factor, we should not discount monetary policy in creating an artificial boom in oil investment.
Now that the oil boom has turned to a bust, the misallocated resources are becoming evident. It is likely that some of the shale oil drilling in the United States never should have happened in the first place.
A Fed Official Weighs In
After the latest unemployment numbers were reported, James Bullard, president of the Federal Reserve branch in St. Louis, commented that despite the gain for those employed, it was the smallest increase since August.
While some economists celebrated the numbers, this Fed official was obviously a lot more cautious. Some analysts are taking these comments and others like them as the Fed leaving the door open to keeping interest rates near zero, where they have been for over six years.
Perhaps these are calculated moves by Fed officials to simply leave the door open. They don’t want to commit too much to a particular policy.
While the unemployment numbers are looking better, stocks have been far more volatile, the oil market is way down, and the current 10-year yield is under 2%. This is all coming after the Fed announced in October an end to its biggest round of monetary inflation in its 100-year history.
It is hard to believe that over six years of a near-zero interest rate may not be long enough, but perhaps that is the message that James Bullard was sending on behalf of the Fed.
The Fed’s Control of Interest Rates
Most of the obsession around the Fed right now is with interest rates and whether it will raise rates some time in the first half of 2015.
But the interesting thing is that the market is actually keeping rates low right now. The Fed has had a policy of tight money for the last three months, yet longer-term rates are down. The Fed is rolling over its maturing debt but not adding to its balance sheet.
Prior to 2008, when analysts discussed the Fed, the main question was always what it would do with interest rates. But that is because the interest rates essentially determined monetary policy. If the Fed wanted to lower interest rates, it would create money out of thin air by buying U.S. government debt. To raise rates, it would sell assets from its balance sheet.
But things have changed over the last six years. The Fed has quintupled the monetary base, but much of this newly created money has gone into excess reserves at the banks. Instead of loaning out the money, it is parked at the Fed “earning” an interest rate of 0.25%.
This has kept the federal funds rate low, which is the rate historically controlled by the Fed — the overnight lending rate for banks. But it hasn’t mattered what the Fed has done over the last several years. Whether it is in monetary-inflation mode or tight-money mode, the federal funds rate stays below 0.25%.
The only effective way to raise rates now is for the Fed to pay a higher interest rate on bank reserves. Of course, this will keep lending down, which the Fed may or may not want. It helps keep price inflation in check, but the Fed may also view it as detrimental to economic growth. It is also less money that will be remitted back to the Treasury each year if the Fed has to pay more to the banks.
So while all of the talk is about raising rates, we have to wonder if the Fed really wants to change things right now, especially when it doesn’t even have as much control as many people think.
Its main monetary tool right now is what it has always been: to create new money out of thin air.
Will We See More QE?
Aside from interest rates, we really have to wonder how much it will take for the Fed to reinstitute another round of so-called quantitative easing, or QE. What is the tolerance level of Janet Yellen and the Fed?
If the stock market goes down 15%, will the Fed do nothing? If the 10-year yield falls further, will the Fed do nothing? If the economy falls into recession, will the Fed do nothing?
While most people see their health insurance premiums rising and their grocery bills going up more modestly, the Fed relies on the government-issued price inflation numbers.
With the drop in energy prices, the price inflation numbers are coming in below the Fed’s target of 2%.
If economic growth becomes flat or goes negative and price inflation is seen as low, then Fed officials may not see much risk in another round of quantitative easing.
Of course, they ignore the fact that this money creation severely distorts the marketplace and misallocates resources on a grand scale. It also helps Congress fund its addiction to more debt.
But while the focus is on interest rates, we shouldn’t be shocked if the Fed eventually starts another round of money creation. If this happens, will we finally get the big boost in price inflation that has yet to come?
To prepare for such a scenario, it is always good to have hard assets to hedge against a depreciating dollar. This means buying and holding precious metals such as gold and silver.
For the long term, oil will still be a good bet, as will real estate — especially when you can get a 30-year loan for 4% or less.
Keep watching the released statistics and how Fed officials react to them. While it is a shame that our economic world is so dependent on the decisions of a few central bankers, that is the reality we live in.
And that is the world we must invest in.
Until next time,
Geoffrey Pike for Wealth Daily
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