What will be the unintended consequences of the Federal Reserve's new policy regime...?
HOW MUCH of the world's woe is the fault of people who claim to know things they don't really know...and to be able to do things they can't really do? asks Daily Reckoning founder Bill Bonner.
Investment advisors said 'housing always holds its value'. How did they know?
Or that 'stocks always go up in the long run'. Oh yeah?
Government bosses tell us they can 'improve the educational system'. Or that we have to mobilize our troops against some foreign devils.
Or there are experts who tell us that we use too much oil...or that we don't have enough. We eat too much fat...or like fish too much. We don't drink enough water, says one. We drink too much coffee, says another.
Practically every week brings a new alarm. A new bit of pseudo-knowledge. And a new initiative at centralized planning to fix the problem.
The world improver knows not only what 'we' should do... but also what the Israelis should do. And the Syrians. And the Chinese. And the Russians. He's got a plan for everyone.
And today we're looking at the central planners at America's central bank. They're sure the world would be a better place if more people had a nine-to-five job... They are not actually planning to do much hiring themselves, but they seem sure that they can induce other employers to increase their payrolls.
How? By lending money that doesn't exist and charging no interest on it.
The New York Times yesterday reported that the Fed plans 'to continue suppressing interest rates so long as the unemployment rate remained above 6.5 percent'.
Why not continue suppressing interest rates until the swallows come back to Capistrano... or until the Great Lakes dry up?
The assumption in the Fed's plan is that there is causal connection between its monetary policy (Zero Interest Rate Policy – ZIRP) and unemployment. Not only that. The program assumes that the Fed governors can understand the connection...and that they can manipulate employment by holding short rates on the floor.
Is it so?
Here's the Times' report:
'To help reduce unemployment, the Fed said it would also continue monthly purchases of $85 billion in Treasury securities and mortgage-backed securities until job market conditions improved, extending a policy announced in September.
'But the Fed released new economic projections showing that most of its senior officials did not expect to reach the goal of 6.5 percent unemployment until the end of 2015, raising questions of why it was not moving to expand its economic stimulus campaign.
'At a news conference after a two-day meeting of the bank's top policy committee, Mr. Bernanke suggested that the Fed was approaching the limits of its ability to help the unemployed.
'"If we could wave a magic wand and get unemployment down to 5 percent tomorrow, obviously we would do that," he said when asked if the Fed could do more. "But there are constraints in terms of the dynamics of the economy, in terms of the power of these tools and in terms that we do need to take into account other costs and risks that might be associated with a large expansion of our balance sheet", referring to the monthly purchases of securities.'
Bernanke has no magic wand. All he has is monetary policy. So, he waves that around instead. But where is the evidence that it has the desired effect? Interest rates have been at zero for four years already. Unemployment is still high.
John Williams of Shadow Stats puts the real unemployment level at 23%, not the 7.9% reported by the Labor Department. Even if you think ZIRP (zero interest rate policy) is responsible for lowering unemployment over the last four years, at the present rate it will take another five or six years before it goes down to the Fed's target. Let's see... what will be the unintended consequences of ten years of ZIRP?
If there is a connection between monetary policy and unemployment it is a slippery one. Interest rates were around 5% when the US economy ran at full employment during the '90s and '00s. Now, at 0%, unemployment is at record highs.
And if interest rates and unemployment are so tightly bound, what will the Fed do when unemployment sinks to 6.5%? Will it then let interest rates rise? If it doesn't, surely it risks a period of 'inflationary overheating' or even hyperinflation. But if it does raise rates, won't unemployment go up again?
So what's the point?
The whole thing is so slimy and stinky, we hesitate to touch it. But an economy only has so much saved money (resources) that can be borrowed and put to work. The Fed can't wave a magic wand to create more capital. All it can do is mis-price it.
The amount of savings compared to the demand for capital is what determines the real interest rate. If the Fed distorts the cost of capital... by setting an arbitrary interest rate... it also distorts the whole economy.
We end up with zombie businesses that can only stay alive if they are pumped up with cheap money...and zombie jobs that depend on artificially-low interest rates. We also get business activity that is fundamentally capital consuming rather than capital creating.
Projects borrow resources without paying the real costs of them. They stay in business, consuming resources, without generating enough real wealth to pay for them. As capital disappears, we all get poorer not richer.
And that's just a critique of the theory. In practice, when has this policy ever worked? Not once that we've ever heard of.
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