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February 20, 2010
The Fed feints
Great hoopla over the Federal Reserve's surprise decision to raise the discount rate 0.25 % fills the media and the markets. Pundits discuss earnestly the spice has been added to the tea leaves. Barry Ritholtz lists three possible motivations behind the Fed's move:
1. Response to political pressures;
2. Proof the Economy is improving;
3. Inevitable ending of extraordinary accommodation.
The relevance of number 1 can be discounted rather quickly. Where could the "political pressure" come from? Other than lip service around election time, Congress never demands fiscal or monetary responsibility. It could refer to "hawks" on the Fed board, but they would not overrule Bernanke on anything substantive, which this move wasn't. Thus points 2 and 3 appear to be possible motivations.
The rate move was miniscule. Its size precluded it from having any meaningful economic effect. Thus, it must be interpreted as a "signal." But was it a signal meant to deceive? That is, was the move a "feint?"
The Fed traditionally sends a signal in advance of taking more serious economic measures. The rationale for a warning is to prepare markets for what is coming. It is believed that markets then adapt somewhat in advance of the future, stronger actions. This move was not a signal. As stated by John Williams of Shadowstats.com:
The Fed move was a feint designed to reinforce beliefs in points 2 and 3 above. But there is no economic recovery, and the Fed cannot stop its extraordinary accommodation.
The end of March will provide the proof. That is when Mr. Bernanke promised to cease Quantitative Easing. QE will not cease. There is not enough market demand to purchase the boatload of Treasuries needed to fund government deficits. New bond issuance needs to average $90 billion dollars per week this year. $40 billion is for new debt, while $50 billion is rollover of maturing debt.
If QE stops, the government defaults on at least some of its obligations. It does not have the money to pay its commitments without these bond proceeds. If Mr. Bernanke stops QE so does the Federal government. If QE stops, so will Social Security checks and other such payments.
Games will be played to attempt to cover up the continuance of QE. These games were played this year. The ultimate test is the level of Federal Reserve assets. What Mr. Bernanke claims is irrelevant. If Fed assets are increasing, so is QE, no matter how surreptitious it may be.
Mr. Ritholtz ends his post with this appropriate quote from Ralph Waldo Emerson:
The Federal Reserve was established as an independent agency with goals to protect the banking system and the purchasing power of the currency. It has failed miserably in both respects. Over time, it also lost its independence and became highly politicized.
If Mr. Bernanke were truly to obey the charter of his agency, he would not enable the government to continue its irrational and ruinous spending. The fact that the government is dysfunctional is even more reason for the Fed to act. To paraphrase Ronald Reagan, "Mr. Bernanke, tear down this government. Do what your office demands."
Mr. Bernanke will not do his duty. But that merely postpones the inevitable. Markets will perform the task, and we will all be the worse for it when they do.
Monty Pelerin blogs at www.economicnoise.com