Today the Fed made history by lowering the fed funds rate to a target of between .25% and zero. That’s right, zero. Nada. Nothing. Ben Bernanke proved that he was a man of his word. Before he was elected chairman, he said that he would lower interest rates to zero to combat the dreaded forces of deflation, and now he’s proven he’s good for it.
Ben’s Christmas gift to the world is an interest rate of nothing.
I read a lot of superhero comics as a kid, and as an adult I love the movies made from them. The figure of a guardian watching over people ready to swoop down and deal a couple of solid punches to evildoers was very reassuring to me as a child. The world painted on the pages of the comic books made the hero indispensable. Without the protection of heroes like Spider-man, the world would be overrun by criminals. Not to mention supervillains.
I’d say that the world we live in today views itself through that comic book prism. Free societies will soon be overrun by fraudsters and criminals if we don’t have super powerful regulators to protect us. Similarly, free markets would soon fall prey to their own excesses were it not for super powerful bankers who can sweep in and defeat the business cycle with a couple of handy rate cuts.
Look, up in the sky. It’s a bird. It’s a plane.
It’s… THE CHAIRMAN!
His super powers include the ability to run the printing presses faster than a speeding bullet… and in so doing make your money lose value. That’s all inflation is, you know — money losing value. Ben hopes that the tonic of a little inflation will get the markets started again. Keynes himself theorized in The General Theory of Employment, Interest and Money that inflation was the great trickster which could get labor to work for lower rates of compensation then they had anticipated. He figured that laborers would be slow to catch on to the difference between nominal wage rates (the number of dollars they were being paid) and real wage rates (what those dollars could buy). Keynes figured that by using the trick of inflation, business would be getting a discount in their labor costs (because he figured labor is slow to catch on) and would therefore become profitable.
It’s never worked, mind you. It didn’t pull us out of the Great Depression despite being tried year after year. It didn’t do a lick of good in Japan, either. Inflation has not cured deep recessions then, and it’s not going to solve this one today. In fact, it was these efforts to use the power of inflation to resist economic downturns that caused the greater downturns down the road in the first place.
In William Feckstein’s short little book, Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve he meticulously traces how Greenspan did little but cut rates through his tenure as chairman. First, he did so at the start of the ’90s to prevent the ’91 recession from deepening. These lower interest rates pushed a lot of savers out of traditional interest-bearing bank accounts and into the stock market in pursuit of higher returns. Greenspan then found that he was powerless to bring the rates back up without crushing these newly-made stock market investors. So he just kept them low despite the “irrational exuberance” he felt was getting priced into the market.
The end of the millennium came, and Greenspan worried that nervous individuals would pull too much liquidity from the system with their Y2K concerns. So in anticipation, he pushed liquidity into the system and helped spike the stock market of ’99 to be one of the best stock market years on record. He again found himself unable to raise interest rates, because of the downturn that ensued after the bursting of the stock market bubble. So, Greenspan just lowered rates AGAIN, inciting a housing bubble. Now his predecessor, Ben Bernanke, is finding that he also could not raise interest rates back to where they were without crushing the bubble and causing a depression. And now he’s having to lower interest rates even lower than Greenspan ever did. To drive this point home, I took the historical data for the fed funds rate from the Federal Reserve’s website and plotted it in Excel. Have a look.
As you can see from the graph, every attempt to raise interest rates after they were lowered caused an economic downturn that necessitated still lower interest rates. As most anyone could guess, this can only go on for so long. Once the fed funds rate hits zero, there’s no more room to cut. And here we are at the bottom. I suppose it’s possible that there may be one more bubble cycle in the American economy, but that will only prolong the inevitable. In real terms, there’s nowhere for the American consumption-driven economy to go but down.
“Fear not,” our chairman, turned-superhero seems to say, “I have other ways to cause inflation.” And he does. As he detailed in his speech on making sure deflation “doesn’t happen here,” the Fed chairman can use all kinds of shenanigans to keep inflation rolling. The fed funds rate is a short-term rate, but Ben wants us to know that with the flip of a switch, the Fed can just start printing up money and using it to purchase bonds in order to drive down interest rates all across the spectrum. So we may be down to a short-term interest rate of zero, but we still have room to cut the mid- and long-terms ones next.
Of course, if one takes this to its logical conclusion, one would figure that once the Fed has manipulated interest rates all across the board down to zero, the inevitable fall that they’ve been prolonging must come to be. That’s assuming that no one catches onto the fact that the Fed is creating trillions of dollars out of nothing in the meantime and just flees the whole monetary system.
Speaking of, gold did very well today, and it’s going to do even better in the future. The more inflation Helicopter Ben forces on us, the more it’s going to reward those who flee the dollar.
If you know of anyone who needs to learn more about this, I’d encourage you to buy them a copy of my book What Do You Mean My Money’s Worthless for Christmas.
It makes an excellent stocking stuffer.