No Way Out as Feds double size of open-ended money printing

By Peter Schiff, CEO of Euro Pacific Cap­i­tal Inc.

(12.14.2012) — By upping the ante once again in its gam­ble to revive the lethar­gic econ­omy through mon­e­tary action, the Fed­eral Reserve’s Open Mar­ket Com­mit­tee is now com­pelling the rest of us to buy into a game that we may not be able to afford. At his press con­fer­ence this week, Fed Chair­man Bernanke explained how the eas­i­est pol­icy stance in Fed his­tory has just got­ten that much eas­ier. First it gave us zero inter­est rates, then QEs I and II, Oper­a­tion Twist, and finally “unlim­ited” QE3.

Now that those moves have failed to deliver eco­nomic health, the Fed has dou­bled the size of its open-ended money print­ing and has announced a pro­gram of data flex­i­bil­ity that vir­tu­ally insures that they will never bump into lim­i­ta­tions, until it’s too late. Although their new poli­cies will cre­ate numer­ous long-term chal­lenges for the econ­omy, the biggest near-term chal­lenge for the Fed will be how to keep the momen­tum going by upping the ante even higher their next meeting.

The big news is that the Fed is now dou­bling the amount of money it is print­ing. In addi­tion to its ongo­ing $40 bil­lion per month of mort­gage backed secu­ri­ties (to stim­u­late hous­ing), it will now buy $45 bil­lion per month of Trea­sury debt. The lat­ter pro­gram replaces Oper­a­tion Twist, which had used pro­ceeds from the sales of short-term trea­suries to finance the pur­chase of longer yield­ing paper. The prob­lem is the Fed has already blown through its short-term inven­tory, so the new buy­ing will be pure bal­ance sheet expansion.

To cloak these shock­ingly accom­moda­tive moves in the garb of mod­er­a­tion, the Fed announced that future pol­icy deci­sions will be put on auto­matic pilot by peg­ging liq­uid­ity with­drawal to two sets of eco­nomic data. By com­mit­ting to tight­en­ing pol­icy if either unem­ploy­ment falls below 6.5% or if infla­tion goes higher than 2.5%, Bernanke is likely look­ing to silence fears that the Fed will stay too loose for too long. While these sta­tis­ti­cal bench­marks would be too accom­moda­tive even if they were rigidly enforced, the goal­posts have been specif­i­cally designed to be com­pletely mov­able, and hence essen­tially meaningless.

Bernanke said that in order to iden­tify signs of true eco­nomic health, the Fed will dis­count unem­ploy­ment declines that result from dimin­ish­ing labor par­tic­i­pa­tion rates. It is widely known that a good por­tion of unem­ploy­ment declines since 2009 have resulted from the many mil­lions of for­merly employed Amer­i­cans who have dropped out of the work­force. But like many other econ­o­mists, Bernanke failed to iden­tify where he thinks “real” employ­ment is now after fac­tor­ing out these work­ers. So how far down will the unem­ploy­ment num­ber have to drift before the Fed’s trig­ger­ing mech­a­nism is tripped? No one knows, and that is exactly how the Fed wants it.

A sim­i­larly loose cri­te­rion exists for the Fed’s other goal­post — infla­tion. Bernanke stated that he will look past cur­rent infla­tion sta­tis­tics and look pri­mar­ily at “core infla­tion expec­ta­tions.” In other words, he is not inter­ested in data that can be demon­stra­bly shown but on much more amor­phous fore­casts of other econ­o­mists who have drunk the Fed’s Kool-Aid. He also made clear that ris­ing food or energy prices will never fall into the Fed’s radar screen of infla­tion dangers.

For as long as I can remem­ber (and I can remem­ber for quite some time) the Fed has stripped out “volatile” increases in food and energy, pre­fer­ring the “core” infla­tion read­ings. But in the over­whelm­ing major­ity of cases, the head­line num­bers are sig­nif­i­cantly higher than the core. In other words, Bernanke sim­ply prefers to look at lower num­bers. In his press con­fer­ence, he made it clear that the Fed will avoid look­ing at price changes in “glob­ally traded com­modi­ties,” that are all highly influ­enced by inflation.

These sub­jec­tive and atten­u­ated cri­te­ria give Fed offi­cials far too much lee­way to ignore the guide­lines that they are putting into place. If the Fed will not react to what infla­tion is, but rather to what it expects it to be, what will hap­pen if their expec­ta­tions turn out to be wrong? After all, their track record in fore­cast­ing the events of the last decade has been any­thing but stellar.

The Fed offi­cials repeat­edly assured us that there was no hous­ing bub­ble, even after it burst. Then they assured us the prob­lem was con­tained to sub­prime mort­gages. Then they assured us that a slow­down in hous­ing would not impact the broader econ­omy. I could go on, but my point is if the Fed is as spec­tac­u­larly wrong about infla­tion as it has been about almost every­thing else, will they be able to slam on the brakes in time to pre­vent infla­tion from run­ning out of con­trol? And if so, at what cost to the over­all economy?

The Fed is com­mit­ting to more than a $1 tril­lion annual expan­sion in its bal­ance sheet, an amount greater than the total size of its bal­ance sheet as late as 2008. Most fore­cast­ers believe that the Fed will have $4 tril­lion worth of assets on its books by the end of 2013, and per­haps more than $5 tril­lion by the end of 2014. If con­di­tions arise that require the Fed to with­draw liq­uid­ity, the size of the sales that would be required will be mas­sive. Who exactly does the Fed believe will have pock­ets deep enough to take the other side of the trade?

As the biggest buyer of trea­suries, it is impos­si­ble for the Fed to sell with­out chances of col­laps­ing the mar­ket. Surely any other hold­ers of trea­suries would want to front-run the Fed, and what buyer would be fool­ish enough to get in front of the Fed freight train? The bot­tom line is that it is impos­si­ble for the Fed to fight infla­tion, which is pre­cisely why it will never acknowl­edge the exis­tence of any infla­tion to fight.

But per­haps the most absurd state­ment in Bernanke’s press con­fer­ence was his con­tention that the Fed is not engaged in debt mon­e­ti­za­tion because it intends to sell the debt once the econ­omy improves. This is like a thief claim­ing that he is not steal­ing your car, because he intends to return it when he no longer needs it. To make the anal­ogy more accu­rate, there could not be any other cars on the road for him to steal.

With­out the Fed’s buy­ing, it would be impos­si­ble for the Trea­sury to finances its debts at rates it can afford. That is pre­cisely why the Fed has cho­sen to mon­e­tize the debt. Of course, offi­cially acknowl­edg­ing that fact would make the Fed’s job that much harder. With­out the mon­e­ti­za­tion safety valve, the gov­ern­ment would have to make mas­sive imme­di­ate cuts in all enti­tle­ments and national defense, plus big tax increases on the mid­dle class.

As I wrote when the Fed first embarked on this ill-fated jour­ney, it has no exit strat­egy. The Fed adopted what amounts to “the roach motel” of mon­e­tary pol­icy. If the Fed actu­ally raised rates as a result of one of its mov­able goal posts being hit, the result could be a much greater finan­cial cri­sis than the one we lived through in 2008. The bond bub­ble would burst, inter­est rates and unem­ploy­ment would soar, hous­ing prices would col­lapse, banks would fail, bor­row­ers would default, bud­get deficits would swell, and there would be no way to finance another round of bailouts for any­one, includ­ing the Fed­eral Gov­ern­ment itself.

In order to gen­er­ate phony eco­nomic growth and to “pay” our country’s debts in the most dis­hon­est man­ner pos­si­ble, the Fed­eral Reserve is 100% com­mit­ted to the destruc­tion of the dol­lar. Any­one with wealth in the U.S. dol­lar should be con­cerned that eco­nomic lead­er­ship is firmly in the hands of irre­spon­si­ble bureau­crats who are com­mit­ted to an ivory tower ver­sion of real­ity that bears no resem­blance to the world as it really is.

Reprinted with permission.

Posted by Randa Wagner on Jan 2 2013. You can follow any responses to this entry through the RSS Feed. Both comments and pings are currently closed.