US$3.6 trillion can buy you a lot of things – planes, boats, penthouses, a lot of useless mortgages, etc. But one thing it hasn’t bought is inflation (at least not officially).
The Fed wants higher inflation and lower unemployment before it dials back the printing presses.
In spite of the Fed’s concerted efforts, inflation is struggling to get off the mat. It has had its post-GFC surges, but cannot sustain the momentum.
The most recent data has inflation around 1.5%. Personally, my view is the lower the inflation the better. Who the heck wants rising prices? Only a government in need of higher levels of tax revenue collected on the higher ticket price, that’s who.
Give me deflation any day of the week. Falling prices would be a welcome change.
The modern economy has been built on inflation. None of us know any different.
However inflation is a relatively modern invention, courtesy of central bankers.
The above graph tracks US inflation since 1800. Inflation was largely non-existent until 1915 (the US Federal Reserve was created in 1913).
The reason for the benign inflation reading prior to 1915 was the economy moved in and out of inflation and deflation. The economy’s own mechanisms for dealing with boom and bust periods corrected the imbalances in both directions. This worked perfectly without any central bank intervention.
Since 1913, the impact of 100 years of Fed meddling in the economy is evident for all to see.
Given this well-established track record it is easy to understand that central bankers are hard wired for inflation and view deflation as the devil incarnate.
In 2002 (prior to becoming Fed Chairman) Ben Bernanke said, ‘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. Deflation is always reversible under a fiat money system.‘
This little speech would have earned Bernanke, at the time, huge brownie points in Washington – the perfect guy to succeed Greenspan.
Since discovering sustained inflation, politicians of all stripes have embraced the concept. Constantly increasing tax revenues made pork-barreling a whole lot easier.
Compare the list of welfare entitlements today with those that existed a century ago. The age pension is about the only one from that bygone era that comes to mind.
It is not just the US that is seeking inflation here, there and everywhere. The Japanese are so desperate to launch out of their two decade long deflationary funk, they have committed to doubling – yes doubling – their money supply in the next two years.
And then there is headline on CNN Money:
This is an extract from the article (emphasis mine):
‘The ECB kept its main interest rate unchanged at a record low of 0.5%. But the central bankers also discussed the possibility of a cut, given a range of threats: weak lending to households and firms, low inflation, and a strong euro exchange rate, which could weigh on exports.‘
The Great Credit Contraction continues to exert its influence. The repudiation of debt (the primary economic driver for the past thirty years) has central bankers in a state of flux.
A decade ago Bernanke thought creating inflation with the printing press would be a snap. What he didn’t figure on is people not being interested in his money – this had never happened before.
Where to from here?
The following is an extract from the Gowdie Family Wealth Newsletter for October 2013 that may give you an insight into what the Fed has in store for us.
When the GFC hit, Bernanke read straight from Greenspan’s recipe book – a pinch of lower interest rates, a dash of easy credit, heat for a few months and hey presto, the ‘wealth effect’ is served.
Ben keeps looking in the economic oven and scratching his head wondering why the wealth effect is failing to rise. Simple Ben, the temperature in the oven is way too low.
The heat has gone from the lending market. Consumers are tapped out.
The following chart compares the loan growth after each US recession since 1973. The current loan growth is tepid to say the least – even with the lowest interest rates in history. Banks and consumers are gun shy.
Recession after recession consumers were enticed further into debt to kickstart an ailing economy. Each time the enticements had to be greater to create the same stimulatory effect.
This time around the central bankers seriously miscalculated the level of debt fatigue in the system. ‘We’ve had enough,’ was the collective cry.
The much touted wealth effect has been isolated to a privileged few. So how does the Fed create the spark to heat up the lending market?
With Bernanke’s tenure at the Fed coming to an end, his likely successor is Janet Yellen – another career academic who happens to be married to a Nobel Prize winning economist. From as near as I can tell, anyone with real life experience is automatically disqualified from applying for the Fed Chairman’s role.
Anyway Ms. Yellen is a Bernanke clone – consistently arguing for lower interest rates to promote economic growth and reduce unemployment. None of this has actually worked, but how wonderful it must be to pontificate from on high about this or that theory.
When Yellen talks about lower interest rates, she means it. On February 22, 2010, she said, ‘If it were possible to take interest rates into negative territory, I would be voting for that.’
Negative interest rates – this means you pay the bank to keep your money.
Just so you are with me on this – invest $100,000 at minus 1% and at the end of the year your investment is worth $99,000.
Sounds preposterous doesn’t it? Well I think it is distinct possibility.
Let’s say we have GFC Mk 2 and it exposes the instability in the global financial system. What has the Fed or any other central bank got left in their arsenal?
When the subprime crisis started to unfold in late 2007, the US cash rate was 5.25%. There was enough ‘fat’ in the cash rate to cut during the course of 2008.
With the US cash rate at 0.25% where do they go from here?
And, if printing $85 billion per month is not doing the trick (and it can be argued it is only making matters worse) then how much more money can they print and still retain the confidence of the markets?
The Fed has clearly demonstrated how desperate it is to keep the debt dependent economy afloat. GFC Mk 2 would only send their anxiety levels through the roof.
Desperate people resort to desperate measures – so perhaps if the conditions became dire enough, negative interest rates are not out of the question.
Compared to our European, Japanese and US counterparts, Australian savers have indeed been fortunate over the past four to five years. However our days of relatively higher interest rates are coming to an end.
As The Great Credit Contraction grinds on, expect our rates to more closely resemble those in the Northern Hemisphere.
If rates do go negative, a chorus of global savers will be begging for an end to this stupidity. Save your breath.
Yellen lives in another universe called Academia. I can assure you the noise from the masses does not carry that far.
Vern Gowdie+
Chairman, Gowdie Family Wealth
Publisher’s Note: This article originally appeared in The Daily Reckoning Australia
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