By Mike Whitney
(The Centre for Research on Globalization) Interest rates. The Fed does not need slinky women in plunging necklines to peddle money. All it needs is low interest rates. When rates are pushed lower than the rate of inflation, the Fed provides a subsidy for borrowing. This is not as hard to grasp as it sounds. If I offered to give you $1.00 for very 90 cents you gave me in return, you would buy as many dollars from me as you could. The Fed operates the same way. It generates market activity by creating incentives for borrowing. Borrowing leads to speculation, and speculation leads to steadily rising asset prices. This is how the game is played. The Fed is not an unbiased observer of free market activity. The Fed drives the market. It fuels speculation and controls behavior by fixing interest rates.
When Lehman Bros flopped last year, markets went into freefall. A sharp correction turned into a full-blown panic. The bubble burst and trillions of dollars in credit vanished in a flash. Trading in exotic debt-instruments stopped overnight. A global sell-off ensued. Markets crashed. For a while, it looked like the whole system might collapse.
The Fed’s emergency intervention pulled the system back from the brink, but the economy is still wracked with deflation. Billions in toxic waste now clog the Fed’s balance sheet. The dollar has fallen like a stone.
When the financial system blows up and credit is sucked down a capital-hole, the economy goes into a downward spiral. Businesses slash inventory and lay off workers, workers have to cut back on spending and credit. That creates less demand for products, which leads to more lay offs. This is the vicious circle policymakers try to avoid. That’s why Fed chair Ben Bernanke wheeled out the heavy artillery and launched the most aggressive central bank intervention in history.
The Fed dropped rates to zero, but its Quantitative Easing (QE) program (which monetizes the debt) actually pushes rates even lower to roughly negative 2 percent.
Bernanke has underwritten every sector of the financial system with government guarantees. He has provided full-value loans for dodgy collateral which is worth only a fraction of its original value. The market can no longer operate without the Fed. The Fed IS the market, which is why it is foolish to talk about a “recovery”. The idea of recovery implies a free-standing system based on supply and demand. But, for now, the government provides the demand, which is why there is no market and no recovery. Analysts at Goldman Sachs sum it up like this:
“How much of the rebound in real GDP was due to the fiscal stimulus, and where do we stand in terms of the effects of stimulus thus far? Although precise answers are impossible at this juncture, several aspects of the report are consistent with our estimates that the fiscal package enacted in mid-February as the American Recovery and Reinvestment Act (ARRA) would have accounted for virtually all of the growth reported for the third quarter.” (http://www.zerohedge.com/article/hedging-their-bets)
Positive growth is an illusion created by government spending. The economy is still flat on its back. Consumer spending and credit are in sharp decline. Unemployment is steadily rising (although at a slower pace) and wages are flatlining with a chance of falling for the first time in 30 years. Deflationary pressures are building. The talk of a “jobless recovery” is intentionally misleading. Jobs ARE recovery; therefore a jobless recovery merely points to asset-inflation brought on by erratic monetary policy. Surging stocks shouldn’t be confused with a genuine recovery.
The Fed faces stiff headwinds ahead. Low interest rates can have unintended consequences. The “cheapness” of the greenback has made the dollar the funding currency for the carry trade. Investors are borrowing low cost dollars and using them to purchase higher interest assets elsewhere. The process, which is rapidly escalating, is fraught with peril as economist Nouriel Roubini points out in an article in the Financial Times:
“Since March there has been a massive rally in all sorts of risky assets… and an even bigger rally in emerging market asset classes (their stocks, bonds and currencies). At the same time, the dollar has weakened sharply, while government bond yields have gently increased but stayed low and stable…
