Wednesday, September 22, 2010

The Fed's Minimum Price Stability, Maximum Unemployment Policy

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The Fed says it's worried about deflation and high unemployment. So in order to tackle these two problems it's going to do more of the same things that lead to them.

In its post meeting statement yesterday, the FOMC said that inflation is 'somewhat below' levels consistent with its congressional mandate for stable prices.  Since the official inflation rate is positive, this indicates that under no circumstance should prices actually remain stable in the U.S. It also means that prices have to increase by more than the amount they are rising now. This of course leads to long-term dollar devaluation and indeed the dollar has lost 96% of its value since the Fed has been in business. They obviously can't wait to lop off the remaining 4%. Having a worthless currency is obviously a good thing as far as the Fed is concerned (you might disagree when you have to pay $5,000 for a loaf of bread). Inflation-sensitive gold hit its fifth record high in as many days on the news and was pushing $1300 an ounce this morning.

It order to tackle the non-existent deflation problem, the Fed intimated that more quantitative easing - also known as money printing - is on the way. There is no case in financial history when excess money printing hasn't eventually led to higher consumer inflation and it has frequently led to hyperinflation. The Fed has already done a lot of 'printing' and the ever increasing price of gold is showing the dollar losing value right in front of our eyes. However, the see no inflation, hear no inflation, and speak no inflation Fed ignores the gold market. Instead they are looking at ever dropping interest rates - the two-year treasury hit another record low after the meeting. Falling interest rates are being caused by all the new money they are manufacturing because bonds are being bought with some of it and this drives their price up and rates down. Using some form of inverted, twisted thinking, they view a market reaction caused by excess money printing as a sign of deflation.

The Fed first lowered its Funds rate to zero in 2008. With help from the U.S. treasury, they have engaged in an expansionary money creating policy since then as well. Unemployment is now much higher than when they started these moves and is stuck around the 10% range if you believe the official numbers (if not, it's much higher). After the worst recession since the 1930s, the economy is stuck in neutral, if you believe the official numbers (if not, we have already entered another recession). So the Fed's solution is to ratchet up the same policies that have failed over and over again and they claim somehow they will work now. It is far more likely the Fed's actions will nstead lead to minimum price stability and maximum unemployment.

Disclosure: No positions.

Daryl Montgomery
Organizer, New York Investing meetup

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.


Heather said...

How much of the rise in gold prices is due to inflation sensitivity, considering other forces at play (notably, many of the conservative talk radio shows that have promoted investing in gold for the last several years)?

Broken Bob said...

Heather, since Mr. Montgomery is not answering, I'll take a stab at it. Gold is popular during periods of great uncertainty -- and this era certainly qualifies. Yes, the right wing nuts are buying it, and rational people are also buying it... and will continue to do so until enough people realize it has manifestly reached "bubble status" and start monetizing their gains. Historically an ounce of gold buys a man's suit (moderate to expensive variety). Now it's buying two or three good suits. Either the average suit buyer will become so flush with inflated cash from his ballooning salary that he will be willing to spend $1,500 or more for such a suit, validating the high gold price (very unlikely, because his corporate boss will not spontaneously triple his wages in this lousy job market), or else the price of gold will correct. When gold was $350, it was a good buy. Now? Not so much! Keep in mind that for every gold enthusiast buying gold and expecting inflation, there are presently ten bond buyers bidding up bond prices (and sending rates sinking) because they expect minimal inflation. At least one of those camps will be proven wrong, and if we eventually get just moderate inflation, both camps will be proven wrong! And that would be my bet, Heather!!