Mr. Bernanke's move to bring down the Federal Reserve Funds Rate to a range between 0% to 0.25% p.a. has had mixed reactions from the world. On the one hand, the Reuters article dated 17 December 2008 entitled "Bernanke voted best in dealing with Crisis" seem to suggest that there are a number of economists that agree with such a Government Policy.
On the other hand, the CNBC article dated 17 December 2008 entitled "Pros say Fed move will create a Bond Bubble" suggest that the Fed may have gone "A Bridge Too Far" on this action to revive the struggling economy.
Andrew Busch's guest blog on CNBC, dated 17 December 2008, entitled "Fed gives Short Term Gain, Long Term Pain", suggest that Americans and maybe the world, will probably live to regret the Fed's decision.
How do we make sense of all these conflicting opinions?
Let's examine the facts. Fact 1 is that the US Economy, and the World Economy for that matter, "has fallen off the cliff", to use the phrase that is now commonly thrown around on CNBC. In short, the economy is in very, very deep trouble.
Fact 2 is that the Federal Reserve has cut its Fed Funds Rate from 5.5% p.a. slightly over a year ago, down to 0% today. It is clear that cutting interest rate has not worked to revive the US Economy. If anything, the US Economy has worsened since the first cut in interest rate.
It is probable that there has been some positive effect achieved by cutting the Fed Funds Rate, in the sense that the loans rate could have been much higher had the interest rate not been cut. However, it is also clear that cutting the Interest Rate will not spur an economy that is plagued by both the lack of consumer and business confidence, and a credit liquidity squeeze, where banks are not only not lending, but actually aggressively withdrawing liquidity from the business world.
Nothing the Fed has done, has managed to change this credit squeeze. As mentioned in my previous blog, the only way for the Fed to improve the credit squeeze situation is to go direct into the business world through new entities (or takeover existing entities), and not merely put tons of cash into the hands of the bankers.
If a person like me, sitting in the quiet of my room can make this statement, Mr. Bernanke, and Mr. Hank Paulson, with all their top, Ivy League, super intelligent people advising them must surely know this potential solution. Thus, we can infer that their policies and actions are not to improve credit squeeze situation, as claimed, but to save the banks.
Putting money with banks that have lost the money being injected does not give the banks any additional funds to lend money. Let's read that again.
Let's say a bank had US$100 billion to lend, and have already used up the US$100 billion by lending it out. With this US$100 billion loan to customers of poor creditworthiness, the bank has lost US$50 billion, since it now knows the customers can't pay.
Even if the US Government puts in US$50 billion into this bank, it has merely put the bank back to Square 1, i.e. in the same position where all its money has been loaned out. Thus, where does the bank find extra money to lend?
On the other hand, the CNBC article dated 17 December 2008 entitled "Pros say Fed move will create a Bond Bubble" suggest that the Fed may have gone "A Bridge Too Far" on this action to revive the struggling economy.
Andrew Busch's guest blog on CNBC, dated 17 December 2008, entitled "Fed gives Short Term Gain, Long Term Pain", suggest that Americans and maybe the world, will probably live to regret the Fed's decision.
How do we make sense of all these conflicting opinions?
Let's examine the facts. Fact 1 is that the US Economy, and the World Economy for that matter, "has fallen off the cliff", to use the phrase that is now commonly thrown around on CNBC. In short, the economy is in very, very deep trouble.
Fact 2 is that the Federal Reserve has cut its Fed Funds Rate from 5.5% p.a. slightly over a year ago, down to 0% today. It is clear that cutting interest rate has not worked to revive the US Economy. If anything, the US Economy has worsened since the first cut in interest rate.
It is probable that there has been some positive effect achieved by cutting the Fed Funds Rate, in the sense that the loans rate could have been much higher had the interest rate not been cut. However, it is also clear that cutting the Interest Rate will not spur an economy that is plagued by both the lack of consumer and business confidence, and a credit liquidity squeeze, where banks are not only not lending, but actually aggressively withdrawing liquidity from the business world.
Nothing the Fed has done, has managed to change this credit squeeze. As mentioned in my previous blog, the only way for the Fed to improve the credit squeeze situation is to go direct into the business world through new entities (or takeover existing entities), and not merely put tons of cash into the hands of the bankers.
If a person like me, sitting in the quiet of my room can make this statement, Mr. Bernanke, and Mr. Hank Paulson, with all their top, Ivy League, super intelligent people advising them must surely know this potential solution. Thus, we can infer that their policies and actions are not to improve credit squeeze situation, as claimed, but to save the banks.
Putting money with banks that have lost the money being injected does not give the banks any additional funds to lend money. Let's read that again.
Let's say a bank had US$100 billion to lend, and have already used up the US$100 billion by lending it out. With this US$100 billion loan to customers of poor creditworthiness, the bank has lost US$50 billion, since it now knows the customers can't pay.
Even if the US Government puts in US$50 billion into this bank, it has merely put the bank back to Square 1, i.e. in the same position where all its money has been loaned out. Thus, where does the bank find extra money to lend?
Again, I am very sure the US Government officials know this. So, it is very clear that the US Government is very intent on bailing out and saving the banks, which benefits the shareholders of the banks, but no one else, at the expense of US taxpayers.
Is there absolutely no valid reason to save the banks? Is there no benefit to the taxpayers at all?
There is one indirect argument for the bailing out of the banks. In the 1929 to 1939 Great Depression era, the US Government adopted a hardline, no intervention policy. Through this policy, 10,000 banks collapsed, mostly by 1933. The hardship of the US people is felt through the loss of their entire lifesavings through no fault of theirs, except in trusting the banks that they put their money with. Thus, my earlier blog, "Is Your Money Safer Under the Mattress?"
Thus, a completely hardline approach of "No Government Intervention" has proven to have aggravated an already fragile economic condition, during the Great Depression era. Nevertheless, the current approach to try to "Save All Banks" seem to err on the opposite extreme!
The US Government can't possibly save all banks and other financial institutions. This is a gross abuse of taxpayers' money, and at best, is a negligent misuse of public funds. Why? Because putting taxpayers' money to cover for bank losses, where the money is already gone, generates no Return on Investment. If this idea was a good one, Warren Buffett and George Soros would be so busy announcing the many banks that they are buying right now.
There might be a need to save some of the "profitable" banks, i.e. banks with a profitable business model that need money to tide over the current critical economic situation. There is no point saving banks that are going to cost the taxpayers a lot of money, for practically no returns on investment.
However, the US Government has been throwing money like a drunkard on a wild party of his life, just before he goes to jail. The world has been watching this action with a worried look on its face.
On the one hand, who would wish for banks to fail? The pain and domino effect consequences are most unpleasant. On the other hand, the action of splashing money like there is no tomorrow, is bound to have some serious consequences down the road! If not, every government in the world would be doing it.
BUT, no other government in the world is able to do what the Fed has done thus far. In our previous blog entitled "Will World Interest Rates Rise in the Next One Year?", we highlight that there is a limit to what even the German Government can do.
Thus, a completely hardline approach of "No Government Intervention" has proven to have aggravated an already fragile economic condition, during the Great Depression era. Nevertheless, the current approach to try to "Save All Banks" seem to err on the opposite extreme!
The US Government can't possibly save all banks and other financial institutions. This is a gross abuse of taxpayers' money, and at best, is a negligent misuse of public funds. Why? Because putting taxpayers' money to cover for bank losses, where the money is already gone, generates no Return on Investment. If this idea was a good one, Warren Buffett and George Soros would be so busy announcing the many banks that they are buying right now.
There might be a need to save some of the "profitable" banks, i.e. banks with a profitable business model that need money to tide over the current critical economic situation. There is no point saving banks that are going to cost the taxpayers a lot of money, for practically no returns on investment.
However, the US Government has been throwing money like a drunkard on a wild party of his life, just before he goes to jail. The world has been watching this action with a worried look on its face.
On the one hand, who would wish for banks to fail? The pain and domino effect consequences are most unpleasant. On the other hand, the action of splashing money like there is no tomorrow, is bound to have some serious consequences down the road! If not, every government in the world would be doing it.
BUT, no other government in the world is able to do what the Fed has done thus far. In our previous blog entitled "Will World Interest Rates Rise in the Next One Year?", we highlight that there is a limit to what even the German Government can do.
Worse, the most significant worry is the potential unintended consequence of Hyper Inflation. My blog has been peppered with numerous articles and video clips that discussed this concern. One example on my blog would be the "Bloomberg Interview of Peter Schiff on 28 October 2008".
Printing Money not backed by Gold tend to give rise to a High Inflationary Environment in the longer term. Exactly how much money printed is excessive depends on the world's reaction to the printing of money.
In this regard, all I can say is that the US Government has been really pushing their luck, very, very far, in the last few months. The world has been accepting the various announcements, US$700 billion for TARP, US$300 billion for Citigroup backstop, US$200 billion for Freddy Mac & Fannie Mae, US$150 billion for AIG, just to name a few.
Printing Money not backed by Gold tend to give rise to a High Inflationary Environment in the longer term. Exactly how much money printed is excessive depends on the world's reaction to the printing of money.
In this regard, all I can say is that the US Government has been really pushing their luck, very, very far, in the last few months. The world has been accepting the various announcements, US$700 billion for TARP, US$300 billion for Citigroup backstop, US$200 billion for Freddy Mac & Fannie Mae, US$150 billion for AIG, just to name a few.
What is the Unintended Consequence of Excessive Printing of Money? The answer, "A Severe Currency Devaluation Crisis leading to High Inflationary Environment."
The current economic situation in the US is one of "THE GREAT RECESSION", i.e. this recession is so deep and painful, that it is like no other ever experienced in the last 100 years, except for the Great Depression.
The question of this current fragile economic situation turning for the worse, into an Economic Depression is plausible, and in fact, the probability is growing with each US Government intervention.
Why? In my opinion, an Economic Depression can only come about due to one of two reasons, i.e.
The current economic situation in the US is one of "THE GREAT RECESSION", i.e. this recession is so deep and painful, that it is like no other ever experienced in the last 100 years, except for the Great Depression.
The question of this current fragile economic situation turning for the worse, into an Economic Depression is plausible, and in fact, the probability is growing with each US Government intervention.
Why? In my opinion, an Economic Depression can only come about due to one of two reasons, i.e.
- Trade Protectionism, leading to a phenomenon of Protectionism throughout the world, or
- A severe US Dollar Currency Devaluation Crisis.
The biggest concern in my mind has been a US Dollar Devaluation Crisis, and thus, for quite some time now, it has been quite puzzling to note the strength of the US Dollar, especially in light of the printing of money phenomenon, by the hundreds of billions of dollars every month.
I have been wondering, "What event will "break the camel's back"? Now, I have the answer. By bringing down the Fed Funds Rate to 0% or even 0.25%, Mr. Bernanke has triggered the one of two events that can plunge the existing Great Recession into an Economic Depression, i.e. the devaluation of the US Dollar.
Whether the US Economy will really go into a Depression, will depend now on how much and how fast, the US Dollar devalues against the world's major currencies.
Now that this new wave has started, stemming the tide will be very difficult. Even if the Fed increases its Interest Rate tomorrow, the Bears shorting the US Dollar will not stop shorting. Why? Because there is a long way for the Fed Funds Interest Rate to climb. If it took the cutting of practically all the Interest Rate to strengthen the US Dollar to the current maximum strength, it will probably take a very high Fed Funds Rate to stop the weakening of the US Dollar.
I have been wondering, "What event will "break the camel's back"? Now, I have the answer. By bringing down the Fed Funds Rate to 0% or even 0.25%, Mr. Bernanke has triggered the one of two events that can plunge the existing Great Recession into an Economic Depression, i.e. the devaluation of the US Dollar.
Whether the US Economy will really go into a Depression, will depend now on how much and how fast, the US Dollar devalues against the world's major currencies.
Now that this new wave has started, stemming the tide will be very difficult. Even if the Fed increases its Interest Rate tomorrow, the Bears shorting the US Dollar will not stop shorting. Why? Because there is a long way for the Fed Funds Interest Rate to climb. If it took the cutting of practically all the Interest Rate to strengthen the US Dollar to the current maximum strength, it will probably take a very high Fed Funds Rate to stop the weakening of the US Dollar.
Thus, the statements of my earlier article, "Will World Interest Rates Rise within the next one year?" is being acted out with each passing day.
By triggering the US Dollar Devaluation with a 0% Fed Funds Rate, I am of the opinion that history will record this Federal Reserve move as its biggest blunder in a series of blunders by the US Government in trying to solve the economic turmoil.
There is not much benefit to be gained by a country that relies heavily on imports for its goods consumption, to devalue its currency. If a country's economy is heavily dependent on exports like China, it makes good sense to devalue its currency to improve the price competitiveness of its products. But then again, history has shown that there has never been a country that has devalued its currency to success and prosperity. So, maybe, the economics textbook theory needs rethinking?
Worse, if a country is heavily dependent on imports, a currency devaluation would mean that consumers have to pay more for the same goods today than yesterday. For a country like the US, where there is no choice but to buy the imported goods because the country's economy has changed structure into a service economy over the last half of the century, there is no real benefit to be derived from devaluing the US Dollar.
The US public and Government will experience the pain of a devalued Dollar within the next few months. Inflationary pressures due to the devalued Dollar will cause new problems for the US Government. What benefit is there to be derived by triggering such an event?
In my opinion, there is no benefit to be derived from a 0% Fed Funds Rate, and in fact, there is no way, the Federal Reserve can sustain this policy for more than a year, as it needs to raise funds to cover its balooning Government Budget Deficit Spending, as well as its Balance of Payments Deficits.
In my opinion, there is no benefit to be derived from a 0% Fed Funds Rate, and in fact, there is no way, the Federal Reserve can sustain this policy for more than a year, as it needs to raise funds to cover its balooning Government Budget Deficit Spending, as well as its Balance of Payments Deficits.
I would conclude with a few fundamental observations as a result of this latest US Government Policy: -
- US Dollar is now weakening at a rapid pace to other world currencies. This trend is likely to continue for a while, albeit occasional corrections due to intervention attempts by central banks of the world.
- The Bonds Market Bubble will burst in the next one year. As is, the interest rate gap differential between the extremely artificial Fed Funds Rate at 0% and the high Business Loans Rate does not reflect the true credit squeeze situation. The Fed will be eventually rendered powerless to control its interest rate, having played with fire for far too long.
- Gold & Oil Prices will rise as part of the Flight to Safety Phenomenon, as the probability and risk of the occurence of the Hypothesis of Hyper Inflation increases. However, I am still skeptical about the potency of Gold Market to sustain its price rise over the longer term. It is possible that Oil has hit its market bottom, at least in the foreseeable future, pending new information of a significant nature.
- US Stock Market will not do well in a deep economic recession aggravated by high inflationary pressures due to a weak US Dollar. The World Stock Markets are highly correlated, and will follow the leadership of the US Stock Markets lower and lower with the passage of time.
- Other Commodities Markets will continue to remain weak, at least in the foreseeable future, mainly because the economy remains deep in recession, and thus, demand continues to weaken, in an Asset Deflationary Environment.
In conclusion, subject to new information that significantly change the current market and economic structure, I am of the opinion that the US and World Economy has turned a corner; a negative corner at that, for the worse, i.e. the devaluation of the US Dollar against the world's major currencies.
This increases the risk and probability of an Economic Depression for the US and the world. It is too early to tell whether this concern will happen. However, in my opinion, the US Government could have reduced such a risk by being less zealous in trying to solve the economic turmoil with a blunt economic management tool that has proven not to work thus far.
This increases the risk and probability of an Economic Depression for the US and the world. It is too early to tell whether this concern will happen. However, in my opinion, the US Government could have reduced such a risk by being less zealous in trying to solve the economic turmoil with a blunt economic management tool that has proven not to work thus far.
You can fool some people some of the time, but you cannot fool everyone all the time. This is one time when the world has woken up. Now, we are in the Economic Phase of Unintended Consequences.
Best wishes,
Ooi
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