The Fed is Shockingly Clueless

Yesterday according to the AP the Federal Reserve released a statement that it, “stands ready to use new unconventional tools, or expand existing ones, to spur lending and consumer spending that could help lift the economy out of a painful recession.” The Fed also signaled  that it will keep the fed funds rate at .25% for “some time” to help brace the economy. The Fed also said it is “prepared” to buy longer-term Treasury securities if the circumstances warrant such action. At its previous meeting in December, the Fed said it was merely evaluating that option.

Are they kidding? Could the Federal Reserve be any more clueless? All of these statements by the Fed show just how clueless the Fed is today and has been for the last 18 months (really the Fed is always clueless but today it’s gone to new heights or at least heights not seen since the 1930’s).

Back in November of 2007 I wrote an article, Are We Headed for Deflation?, in which I explained that the US economy was suffering heavy losses of money from the economy due to the continuing write-offs from financial institutions. This is exactly the situation for which the Federal Reserve was created for back in 1913. To prevent the US economy from experiencing losses of money from the economy which would then prevent the resulting deflationary times and economic contraction which Must follow in every economy that suffers heavy losses of money.

The first sentence of the Federal Reserve Act states “Provided for the establishment of Federal Reserve Banks, to furnish an elastic currency, . . .”

“To furnish an elastic currency” means that the Federal Reserve is charged with preventing losses of money from the economy. When money is lost from the economy the currency becomes inelastic. When the currency becomes inelastic people slow their spending and borrowing which causes economic contraction. People slow their spending and borrowing when a currency becomes inelastic for one simple reason. It’s in their best interests to do so.

When money is lost from an economy all remaining money increases in value in the same way that if a portion of the world’s gold supply was lost the value of the remaining gold would rise. As money increases in value it is in everyone’s best interests to slow their spending and borrowing of money. Why would you buy something today using money that is increasing in value because tomorrow your money will buy you even more? Why would you borrow under these circumstances? The money you borrow today will be worth more in the future when you have to pay it back. Under these circumstances people will greatly slow their spending and borrowing of money.

That is where we are at today. As money has continually been lost from the economy due to financial write-offs, consumer spending and borrowing has fallen through the floor. Our currency has become inelastic over the last 18 months. Over the last 18 months the Federal Reserve has failed to do what Congress created it for and charged it to do, “to furnish an elastic currency”.  

So the Federal Reserve’s statements yesterday show just how clueless the Federal Reserve is. The Fed stands ready to use new tools or expanding existing ones? The Fed is “prepared” to buy long term Treasuries? What exactly is the Federal Reserve waiting for? Ten percent unemployment and 10% negative GDP growth? What exactly would it take for the Federal Reserve to finally do what Congress created it to do and furnish an elastic currency?

Buying long term Treasuries would add money into the economy and that money would replace the lost money from the financial write-offs. If the Fed purchased enough long term Treasuries, or really any assets in the economy for that matter, the Fed would take away the appreciation that has occurred in our money over the last 18 months and do what Congress created the Fed to do, “furnish an elastic currency”. Once the appreciation that occurred in money was gone people would start spending and borrowing money again at normal levels. If money is no longer gaining in value and will not buy you more things tomorrow than today there is no reason not to spend it today. If money is no longer gaining in value then their is no reason not to borrow it. The money you have to pay back will not be worth more when you pay it back.

The Fed also said it will keep the fed funds rate at .25% for some time. Again displaying how clueless they are. A money supply will grow of its own accord as money turns over in an economy. Each normal year a money supply will grow of its own accord as people earn returns on their money. Mainly people earn interest on their money. If all money in circulation earns 3% interest on average the money supply will increase by that much minus all write-offs taken by financial institutions. But today the Federal Reserve has the fed funds rate at .25%. Meaning most people are earning very little interest short term. So natural money supply growth is being strangled by the Federal Reserve today. This means that in order for the money supply to grow today the Federal Reserve has to supply almost all of the money. Very little natural money supply growth will occur with a .25% fed funds rate in effect (the Fed has learned nothing from what happened to Japan).

So the Federal Reserve has really made the loss of money in the economy even worse by lowering the fed funds rate so drastically. The Fed is preventing natural money supply growth from really occurring and that only exacerbates the loss of money from the economy problem. With a .25% fed funds rate only the Federal Reserve can cause real money growth in the economy. Yet the Federal Reserve only stands “prepared” to do this (it would do this by buying long term Treasuries).

Every time the Federal Reserve releases statements it shows just how shockingly clueless it is.