Monday, June 30, 2008

The Federal Reserve May Have a Hidden Agenda

If I had a seat on the Federal Reserve, I would have voted for a quarter-point increase in rates at the latest meeting. I believe that the low federal rates are not being passed along to consumers partly because of inflationary expectations. In other words, low rates are not helping as much as they normally would to get the economy back in growth mode because they are fueling short term inflation and long-term inflationary expectations. They are helping to prop up the idiots who run the nations major banks by allowing them to borrow at low rates and lend at high rates, but a quarter-point increase would not have cut into that game substantially.

A quarter point rise would have had an immediate positive impact on the dollar, which would have the effect of decreasing the contract price of oil, which in turn would reduce gasoline prices and give consumers some cash (or credit) to buy other items.

Gradual quarter point rises would not hurt the housing market or dampen the economy in any way. Four quarter point rises over the course of one year would only raise interest rates to 3%, which is still extremely accommodating.

The bankers who have been given seats on the Fed presumably know all this. Do they want to keep gasoline prices high? Are they willing to sacrifice the economic health of the middle class and working class to achieve an extra quarter-point differential in bank profitability? Well, yes, after all they are bankers. But I think there is another item that has been on the agenda for decades now. The Federal Reserve statements don't mention it, and neither does the financial press, at least not in the context of interest rate decisions.

Interest rates have an large long-term impact on the size of the national debt and the annual payments on that debt. This is not a new problem, but the size of the national debt has reached a magnitude that it impacts the Federal Reserve's leeway to raise rates. This is the real reason rates have been kept consistently too low for the last two decades.

The national debt as I write stands near $9.37 trillion [See debt clock]. Interest paid on it is an average over different time terms for the debt and different points where the debt was auctioned off. However, choose a nice round number like 1%. Over the course of 10 years most of the bonds representing the debt are turned over, so if my hypothesis is that the Fed is keeping rates on average 1% lower than would be ideal for their basic mission (economic expansion with minimal inflation), we are talking about saving the federal government 1% a year on debt. In round numbers, that is $94 billion a year. Over ten years, you can round up to a trillion dollars.

Now look at a truly bad scenario. What if, to fight inflation, the base rate was raised from 2% to 5%? Over ten years we are talking $3 trillion.

What should have happened during the late 1990'2 was the Fed should not have accommodated Congress, the President, and stock market speculators. The Fed is accommodating a federal budget that keeps taxes low on rich people and corporations, but spends a lot of money that mostly goes into corporate coffers. The War on Terror is great for defense contractors, but it is killing the economy. And the terrorists know it.

American Seniors pay for all this in another way. They tend to have their liquid capital in CDs. Low interest rates set by the Fed hurt senior retirement income disproportionately.

The war on terror should be handed over to the CIA and military special operations groups. Having a lot of soldiers on the ground, like we do in Iraq, is an ineffective waste of taxpayer money.

I believe we are in a situation where we can have better long term prosperity by raising interest rates modestly, cutting federal spending modestly - mainly in the Defense budget, and raising taxes modestly. But given the control of the Federal Reserve by the self-serving banking industry and the weakness of the current President and both major party Presidential candidates, I am not using that scenario to model the future.

I am modeling an ever-expanding national debt that will at some point hit a tipping point and turn the United States into a 2nd rate economic and military power. It happened to England after World War II, it happened to the USSR in the 1970s, and it is going to happen here, the only question is when.

Which, by the way, does not mean I'm pessimistic about my stock portfolio. Many individual corporations will survive this calamity, if necessary by basing themselves in countries that run their economies on a more rational basis. Owning companies that have strong intellectual property and management teams is the best economic bet Americans can make right now.

1 comment:

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