If Federal Open Market Committee (FOMC) members were to center their December
07 rate decision around the basis of Treasury Secretary Paulson's continually
Dollar Policy" there is absolutely no way they could make a rate cut, as
the dollar is falling off a cliff and its rate of decent is increasing.
So what is happening in the financial realm and why is the dollar falling
so fast? Well, a big part of the answer to this question relates directly to
debt and the creation of money.
For those of you who don't know, every dollar in circulation today was actually
borrowed into existence and was created from nothing. For many years this creation
of new money through debt was not a problem. As long as the debt could be adequately
serviced and various conduits (banks) were open to/available to take on new
debt, the system worked just fine.
Recently however, it has become abundently clear to our Federal Reserve Policy
makers that massive US debt loads are proving very difficult to service, while
at the same time our banking systems are having problems allowing for the creation
of new debt (hence new money). This is all VERY BAD news that could cause a
systemic implosion if not dealt with swiftly. Therefore, the Fed is monitoring
this crisis closely and is lowering short term borrowing rates while injecting
massive amounts of new money (through new bank debt) into the banking systems.
This combination of excessive liquidity (monetary injections) and lower rates
is causing the value of the dollar to plummet. See video below for a better
understanding of this whole debt-to-money process (
Video Summary: money is created through debt and in order to keep an economy
expanding, debt loads must continually expand (increasing money supply) or
else a deflationary environment sets in.
As previously stated: today, after many years of cheap/easy credit (much of
it subsidized by foreigners --
used to suck up 80% of the world's surplus savings) US debt loads are now
at an all time high and adequately servicing this debt has become a huge problem.
A perfect example of this problem is the US housing market. Back in the heyday
of our irrationally exuberant housing market, nearly anyone could qualify for
a mortgage. We had >100% financing, super low teaser rate mortgages and
Loans (No Income, No Job, No Assets). All this easy money led to no-risk
investment speculation and caused a huge new wave of home buyers (many who
couldn't previously qualify). This led to supply/demand imbalances, which drove
home prices up dramatically.
Today however, things are a bit different. As these initial teaser rates on
millions of mortgages began to reset, servicing this additional debt became
unbearable for many and defaulting was the only option. These defaults (in
the $ tens of billions per month) eventually led to the collapse of several
hedge funds, a significant tightening of lending standards and ultimately to
a complete immobilization in the Securitized Mortgage Backed Commercial Paper
market -- where recent financial losses & bank write downs have been massive
(yet merely the tip of the iceberg to date).
But, these write downs are only making matters worse, as each dollar of the
losses eats into available bank capital, creating an additional burden to future
lending, which tightens lending standards further, prevents the creation of
new debt, and causes further downward price pressures on all those homes that
Additionally, part of the domino effect caused by reduced home sales (due
to less available credit) is lowered sales volume at home improvement, furnishing
and a myriad of other stores -- cutting into business profits, leading to less
work hours, increased layoffs, et cetera.
Ultimately, reduced credit leads to reduced money creation, which leads
to reduced spending which leads to a deflationary environment.
That is where we are today... The beginning of a deflationary environment
poised to implode the economy...
Well have no fear Ben Bernanke and the boyz are here!
In a 2002 speech before the National Economists Club in Washington, D.C.,
Ben Bernanke made it clear the Fed should do everything in its powers to prevent
Making Sure "It" Doesn't Happen Here
So, what are the tools Ben feels the Fed should use to prevent deflation?
Well, based on his comments, the Fed could cut rates to ZERO, while simultaneously
they could print/inject massive amounts of fiat money into the system. See
excerpts of the link below (Note: Emphasis is mine)
" But suppose that, despite all precautions, deflation were to take hold
in the U.S. economy and, moreover, that the Fed's policy instrument -- the
federal funds rate -- were to fall to zero. What then? In the remainder
of my talk I will discuss some possible options for stopping a deflation
once it has gotten under way".
Could this comment be a sign of things to come -- Zero percent?
"Like gold, U.S. dollars have value only to the extent that they are strictly
limited in supply. But the U.S. government has a technology, called a printing
press (or, today, its electronic equivalent), that allows it to produce as
many U.S. dollars as it wishes at essentially no cost. By increasing the
number of U.S. dollars in circulation, or even by credibly threatening to
do so, the U.S. government can also reduce the value of a dollar in terms
of goods and services, which is equivalent to raising the prices in dollars
of those goods and services. We conclude that, under a paper-money system,
a determined government can always generate higher spending and hence positive
There you go, he said it -- print more money to reduce its value and to generate
more spending (sounds like a call for Hyperinflation)
"Of course, the U.S. government is not going to print money and distribute
it willy-nilly (although as we will see later, there are practical policies
that approximate this behavior). 8 Normally,
money is injected into the economy through asset purchases by the Federal
Reserve. To stimulate aggregate spending when short-term interest rates
have reached zero, the Fed must expand the scale of its asset purchases or,
possibly, expand the menu of assets that it buys. Alternatively, the
Fed could find other ways of injecting money into the system -- for example,
by making low-interest-rate loans to banks or cooperating with the fiscal
authorities. Each method of adding money to the economy has advantages and
drawbacks, both technical and economic. One important concern in practice
is that calibrating the economic effects of nonstandard means of injecting
money may be difficult, given our relative lack of experience with such policies. Thus,
as I have stressed already, prevention of deflation remains preferable to
having to cure it. If we do fall into deflation, however, we can take comfort
that the logic of the printing press example must assert itself, and sufficient
injections of money will ultimately always reverse a deflation."
I believe what he's saying is: the Fed will reduce rates simultaneously while
increasing liquidity, but the fireworks (printing/monetary injections) will
really have to pick up steam once we're at zero because the Fed's ammunition
canister will then be empty.
"The Fed should and does use its regulatory and supervisory powers to ensure
that the financial system will remain resilient if financial conditions change
rapidly. And at times of extreme threat to financial stability, the Federal
Reserve stands ready to use the discount window and other tools to protect
the financial system, as it did during the 1987 stock market crash and
the September 11, 2001, terrorist attacks."
Huge discount window operations have become a regular thing of late, while
the rules were recently changed to allow banks to pledge a broader range of
commercial paper as collateral. Are we currently experiencing an extreme threat
to our financial stability? Nah, can't be -- the media keeps telling me everything
"Unlike some central banks, and barring changes to current law, the Fed
is relatively restricted in its ability to buy private securities directly. However, 12 the
Fed does have broad powers to lend to the private sector indirectly via banks,
through the discount window. Therefore
a second policy option, complementary to operating in the markets for Treasury
and agency debt, would be for 13 the Fed to offer fixed-term loans to banks
at low or zero interest, with a wide range of private assets (including,
among others, corporate bonds, commercial paper, bank loans, and mortgages)
deemed eligible as collateral. For
example, the Fed might make 90-day or 180-day zero-interest loans to banks, 14 taking
corporate commercial paper of the same maturity as collateral. Pursued
aggressively, such a program could significantly reduce liquidity and term
premiums on the assets used as collateral. Reductions in these premiums would
lower the cost of capital both to banks and the nonbank private sector, over
and above the beneficial effect already conferred by lower interest rates
on government securities. " 15
Minus the zero interest, I think we're already there.
Bottom Line: Back in 2002, Ben Bernanke highlighted what he would like to
do if faced with the problem of deflation. Well, his test has just begun and
deflation is now standing at our doorstep. Thus far,
consumer price inflation raging and the dollar tanking around the globe,
Ben and the Boyz have been working overtime in an attempt to bail out our banking/financial
sectors. They see the approaching financial train wreck, barreling downhill
at ever increasing speed, and although they would really like to back Treasury
Secretary Paulson's Smoke and Mirrors "Strong Dollar Policy", it is far too
late for that. They are now stuck between a rock and a hard place (Deflation/financial
collapse is the rock; Hyperinflation is the hard place) and they have chosen
the hard place -- Hyperinflation
With bank losses mounting, Ben and the Boyz know that they are waay behind
the power curve in their rescue attempts and that deflation is setting in.
Therefore, I feel pretty confident in predicting that come December 11th, rates
WILL once again be cut.
As an aside, If we are fortunate enough to evade a complete systemic banking
failure, I think the tools used (printing presses and helicopters) will force
us into a Hyperstagflationary environment (Hyperinflationary consumer price
inflation combined with slow-to-no output growth, rising unemployment, and
recession) This should allow us to muddle through until ~ 2010, but unfortuantely
I don't think the "Big D" can be avoided forever. My bet is: 2011/2012.
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