The Impotence of Monetary Policy and the Federal Reserve

The job of central bankers is to prevent free-market forces from impacting an economic situation.

Monetary policy apparently cannot halt a previously declining manufacturing sector.

 The Federal Reserve's record level of accommodations hasn't helped.  Any benefits of those moves have been scooped up by the federal government via reduced borrowing costs.  When the Fed steps into the weekly Treasury auctions and buys those Treasury obligations, it is merely lending new money to the federal government.


Japan was the first to delve into the era of near-zero interest rates. 


We can see what their budget deficits did during the contrived low-interest rate environment.  Low rates increased borrowing and deficits.  Ben, have you noticed?

Their manufacturing  has not responded.

The United States and Japan have lost manufacturing due to other factors.  Zero interest rates do not cure that which interest rates did not cause.  But zero interest rates are the drug of choice for more government borrowing and spending.

The net effect of governments setting zero interest rates, then borrowing wildly at those addictive levels, is the denial of a fair return on savings and investments for the people.

People are the ultimate consumers, and when money is taken from their hands, consumption, especially the purchase of services, suffers.  The money that was once "fair return" has been kept by the government and denied the savers. 

It is a dangerous situation when the borrower sets the rates.

But, just like in Japan, we see the end results.  First, when all the buttons have been pushed, the Federal Reserve becomes impotent.  It plays best between the 20-yard lines, to use a football metaphor.  But now that the field has been made shorter, with the room to move now practically nonexistent, the Fed has made itself nearly irrelevant.  And the people there have acquired a three-trillion-dollar portfolio of interest bearing instruments in the process.

A real substantial stimulus would be to allow the market to return to a real interest rate environment, rather than this Botox-induced state we are in.  Historically, rates for savings and other short-term instruments were enough to cover inflation, plus an increment more to induce savings.  Remember when savings was a good thing to promote?  Even during the Greenspan era, the Fed attempted to promote savings...for a while.

This return to a fair return on money would put dollars back in the hands of consumers and provide a real stimulus for the economy.  But alas, it cannot happen.  With the federal government spending nearly 6% of its budget on debt service now, at these contrived low levels, going back to the rates of just five years ago would be a budget-buster.

Add in the Federal Reserve's three-trillion-dollar portfolio.  The Fed has been patting itself on the back for the money it has made.  The face values went up as the interest rates went down.  Great trading.  (Helps to have the answer key, doesn't it, Ben?)  But if rates somehow rise, via intent or market forces, this portfolio will decline sharply in value.  Another reason why low rates are here to stay.

The decline in manufacturing in the U.S. and Japan began well before the 2008 financial crisis.  The decline was due to other factors, most notably the awakening of China, South Korea, and others of the Pacific Rim.  Taxes, labor costs, trade policy, and competition are the culprits here, not interest rates.  The low rates haven't helped manufacturing, but they have certainly taken the buying power away from savers and return seekers. 

Like the cowboy who is out of bullets and keeps clicking and flicking the gun as if a bullet might roll out the barrel, Bernanke hints at QE3.  Fewer people listen.  The Fed is making itself irrelevant.

Perhaps Ben could revisit his Botox economy.  The stock market is up near all-time highs.  All that managed money seeking fair return has been channeled to stocks, gold, and other commodities.  People have been cattle-driven to 2%-dividend-yielding stocks, just to get a near-fair return.  But at what risk?  Everyone once thought real estate was the ticket to financial freedom.  How did that cattle drive work out?