Beware The Fed Tide

By: John Browne | Fri, Nov 5, 2010
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This week, desperation became palpable at the Fed. In both the formulaic statement that accompanied its FOMC policy decision and Chairman Ben Bernanke's unusual (and clumsy) Washington Post op-ed follow up, the guardians of our currency expressed grave disappointment at the slow pace of US economic recovery and emphasized the continued threat of deflation. The Fed is now pledging to defeat this recession using any monetary means necessary. Unfortunately, their embrace threatens to smother our economy.

Despite its paternalistic rhetoric, the Fed really has just a few simple goals: allow for the perpetual expansion of the federal deficit, push up stock prices to create the illusion of wealth, and stimulate consumer spending. To do this, the Fed will hold interest rates near zero for the foreseeable future, and will buy some $600 billion of US Treasury debt by April of next year. Per capita, the commitment to quantitative easing comes to almost $2,000 per American. What's more, if this program fails to pull the economy out of recession, the Fed stands ready to up the ante. This amounts to little more than gambling; but instead of using their own accounts, the central bankers are wagering the nation's savings.

Having already committed $1.7 trillion in the first round of quantitative easing, the Fed is rolling the dice once again - despite ample evidence that their costly remedy won't work.

According to the Fed's own analysis, the US economy continues to disappoint, despite the massive QE-1 cash injection. Given the poor fundamentals: rising unemployment, plummeting house prices, and falling stock prices, it should come as no surprise that consumer confidence is low and spending continues to lag.

Now, by monetizing almost the entire federal deficit through QE-2, the Fed hopes to give Congress the breathing room to enact reforms before skyrocketing interest rates bankrupt the Treasury. Meanwhile, the central bank hopes that the expected inflationary consequences will be nullified by a resulting broad-based recovery. But an economist as knowledgeable and experienced as Chairman Bernanke should know by now that any real economic revival will come from private industry, not government. The money printed by the Fed will indeed flow into the economy, where it will push up asset prices in many sectors. Already commodity prices are soaring. But inflation cannot create real growth.

What the Fed is doing, essentially, is forcing consumers to spend their cash hoardings. Until the economic and financial policies of the government change dramatically, those who are tempted to invest their savings within the United States risk increasing regime uncertainty. So, much of our domestic capital is flowing into hard assets and overseas markets.

This will do nothing to help the festering wounds underlying the US economy.

For example, the problems within the real estate market remain toxic. Combined with falling margins, they threaten the banks with a second crisis. The probability of a mortgage-related crisis in the housing market has further increased by the unresolved "robo-signing" scandal, in which legitimate foreclosures have been blocked by sloppy paperwork. Given the truly abysmal state of documentation for foreclosed properties that had been bought with securitized loans, it is hard to imagine that this problem will be resolved anytime soon.

Surveying the landscape in the mortgage market and elsewhere, it becomes apparent that the only bankable asset America has left is a reservoir of confidence in our country's role as the global economic leader. But confidence can be ephemeral. Usually, even gradual erosion of credibility reaches a latent tipping point. When change comes, it does so with alarming speed.

When international confidence in the US evaporates, those holding dollars will be holding worthless paper. Furthermore, if the US dollar retains its privileged position as the international reserve currency while it spirals downward, the entire structure of international fiat money will be threatened.

In the turmoil that lies ahead, America's saving grace could have been a reliable currency to brace us up. Yes, our legs are weak, but at least we could have had firm ground on which to walk. The present Governors of Federal Reserve, however, would prefer to prop up the bloated and hobbled bubble-era structures in the hopes that a deus ex machina will save the day. Unfortunately, while they're waiting for a miracle, we'll all be left swimming against a tide of new dollars.

 


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John Browne

Author: John Browne

John Browne, Senior Market Strategist
Euro Pacific Capital, Inc.

John Browne

John Browne is the Senior Economic Consultant for Euro Pacific Capital, Inc. Mr. Brown is a distinguished former member of Britain's Parliament who served on the Treasury Select Committee, as Chairman of the Conservative Small Business Committee, and as a close associate of then-Prime Minister Margaret Thatcher. Among his many notable assignments, John served as a principal advisor to Mrs. Thatcher's government on issues related to the Soviet Union, and was the first to convince Thatcher of the growing stature of then Agriculture Minister Mikhail Gorbachev. As a partial result of Brown's advocacy, Thatcher famously pronounced that Gorbachev was a man the West "could do business with." A graduate of the Royal Military Academy Sandhurst, Britain's version of West Point and retired British army major, John served as a pilot, parachutist, and communications specialist in the elite Grenadiers of the Royal Guard.

In addition to careers in British politics and the military, John has a significant background, spanning some 37 years, in finance and business. After graduating from the Harvard Business School, John joined the New York firm of Morgan Stanley & Co as an investment banker. He has also worked with such firms as Barclays Bank and Citigroup. During his career he has served on the boards of numerous banks and international corporations, with a special interest in venture capital. He is a frequent guest on CNBC's Kudlow & Co. and the former editor of NewsMax Media's Financial Intelligence Report and Moneynews.com. He holds FINRA series 7 & 63 licenses.

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