Does The Federal Reserve Know What It Is Doing?

Posted 11/5/10

Does The Federal Reserve Know

What It Is Doing?

KINGSTON, NY, 5 November 2010 — In an effort to stimulate the economy, the Federal Reserve is attempting to drive exceedingly low interest rates yet lower by purchasing $600 billion …

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Does The Federal Reserve Know What It Is Doing?

Does The Federal Reserve Know What It Is Doing?
KINGSTON, NY, 5 November 2010 In an effort to stimulate the economy, the Federal Reserve is attempting to drive exceedingly low interest rates yet lower by purchasing $600 billion more of Treasury debt by June of next year. The idea is that by making credit more plentiful, businesses and individuals will be able to borrow on easier terms, thus helping to revive investment and consumer spending. The Fed’s decision is puzzling. Interest rates already are very low. Even if the Fed succeeds in reducing them a bit more, the stimulative effect is likely to be small. In fact, the Fed’s low interest rate policy denies interest income to retirees and reduces consumer spending by more than it increases it via credit expansion. In all likelihood, the Fed’s purchases will be offset in whole or part by reductions in purchases by other parties. The interest rate on US Treasuries is already too low to compensate for the potential rise in inflation and decline in the dollar’s exchange value. The US is a heavily indebted country with financing needs for massive deficits. Debt monetization, with its inflationary implications, might be the only way for the US government to cover its red ink. Indeed, the Fed’s explanation of its bond purchases as a stimulative policy might be cover for what is in reality a policy of financing the federal budget deficit with newly created money. Such suspicions have increased the concerns about the values of dollar-denominated assets. Since the Fed announced its bond purchases on November 3, the dollar has dropped sharply against other currencies and precious metals. If this response continues, purchases of Treasury bonds, except for the Fed’s, would dry up. If foreign holders of US assets decided that the yield is insufficient to cover the dollar’s loss of purchasing power, they are likely not only to stop buying more but also to begin selling off their stocks of Treasuries and other dollar assets and converting the dollars into other currencies and precious metals. Such a sell-off would more than offset the Fed’s purchases. Faced with a declining dollar and a rising interest rate as Treasury prices fell in the sell-off, the Fed would lose control. Perhaps the Fed has been overcome by hubris, but it is hard to imagine that the Fed has not considered that too much money creation will undermine the Treasuries that it is trying to support. I suspect that the Fed is relying on other countries to protect their exports to the US by printing their currencies and purchasing US dollars in order to prevent rises in the dollar values of their currencies. In other words, the Fed believes that by inflating the dollar, it can force other countries to inflate also. Such a policy could temporarily succeed. However, as countries printed money in order to protect their exports, the adverse effects on their economies would exceed the value of preserving their exports to the US. At that point dollar flight would ensue, and the dollar would cease to be the world’s reserve currency. The dollar’s loss of the reserve currency role would free the world of the burdens imposed by US economic and foreign policies. The wars and economic bullying would stop, because the US would have no way of financing its foreign aggressions or imposing economic penalties on countries that do not comply with its dictates. The US economy cannot be revived unless the budget and trade deficits can be reduced. This would require ending Washington’s hegemonic wars and bringing the offshored jobs back to the US. The military/security complex will not want the wars stopped, and the multinational US corporations will not want offshoring stopped. Therefore, the crisis imposed by the American imbalances will continue as long as the world tolerates it. When the world ceases to tolerate it, the crisis will be America’s alone, and the crisis will devour the country. From many foreign perspectives, the silver lining is the end of the Empire.

by Paul Craig Roberts

Trends Alert Social Security October 14, 2010 War and Bankers First, Social Security Retirees Last Policymakers agree that the US economy is driven by consumer spending. Yet the same policymakers, when confronted with an economy that is not recovering, appear unable to turn their attention to consumers’ inability to spend. When will the policymakers get around to considering the devastating impact of near zero interest rates on the spending power of retirees and people dependent on investment income?  With federal policies denying them interest income, American retirees are currently forced to spend-down their savings. As their wealth diminishes, so do their prospects of future earnings. Washington has now compounded this erosion of consumer demand by denying Social Security recipients, for the second year in a row, a cost of living adjustment (COLA). According to the measure of inflation newly adopted during the Clinton administration, the US economy has experienced a second year of no inflation or of insufficient inflation for a cost of living adjustment to be made. According to the Social Security Administration, Social Security is the primary source of income for 64% of retirees and comprises 90% of the income for one-third of all retirees. The National Center for Policy Analysis estimates that Social Security accounts for virtually all of the discretionary consumption of households with modest preretirement incomes (less than $50,000 a year for couples or $25,000 for singles) and is equal to about one-third of the consumption of the highest-earning households (couples with preretirement incomes of $500,000 and singles with $250,000). Little wonder consumer demand is collapsing. Social Security retirees are being denied a cost of living adjustment, because of the reconfigured Consumer Price Index (CPI) introduced by the Boskin Commission, formally known as the Advisory Commission to Study the Consumer Price Index. The Boskin Commission decided that the traditional way of measuring the CPI overstated inflation, thereby over-compensating Social Security retirees and adding to the US budget deficit. The traditional way of measuring the CPI measured the weighted values of a fixed basket of goods. Thus the CPI was comparable from one year to the next. The new way of measuring inflation replaces the fixed market basket of goods with an ever-changing basket by introducing the principle of substitution. For example, if the price of sirloin steak rises, the new CPI substitutes a cheaper cut of steak, such as round steak. If ground sirloin hamburger rises in price, the CPI substitutes ground chuck. If the cost of ground chuck rises, presumably the CPI adds in hamburger helper. This change makes some sense, as consumers on budgets do substitute cheaper items for those that become too expensive. But as a result, the CPI no longer measures a constant standard of living. Indeed, the principle of substitution guarantees a declining standard of living. The CPI COLA formula for Social Security does not permit retirees to maintain a consistent standard of living. For an estimate of how much Social Security retirees are short-changed by the Boskin Commission’s CPI, established in 1996, consider the inflation measures provided by statistician John Williams (, who continues to calculate the CPI according to the methodologies used by the US government in 1990 and 1980. Williams reports that the current rate of inflation is 4.5% according to the 1990 methodology and 8.5% according to the 1980 methodology. Anyone who has been shopping for food and drink knows that Williams’ measures are far closer to reality than the new CPI. The change in the CPI was expected to save $148 billion between 1996 and 2006, a sum that has been squandered many times over in the bank bailout and invasions of Iraq and Afghanistan. Treasury Secretary Hank Paulson’s bank bailout alone was five times larger than the projected ten-year savings resulting from stiffing Social Security retirees. According to economist Joseph Stiglitz and budget expert Lina Bilmes, the cost to Americans of the Iraq war was 20 times that of the “savings” realized from bilking Social Security recipients for a decade. The cost of the Afghan war, now in its 10th year, promises to be even higher. The US government has, thus, made it completely clear that retirees count for nothing against the interests of the big banks and the military/security complex, which are rolling in record profits while retirees sink into poverty. Reuters reported on October 12 that three dozen top banks and securities firms will pay a record $144 billion in salary and bonuses this year. Employees of merely 36 financial institutions are due annual pay equal to the sum stolen from Social Security retirees over ten years by a reconfigured CPI designed to minimize the cost of living adjustment. These hard facts make it clear whose interests the US government really represents. by Paul Craig Roberts P.S. The Autumn Trends Journal is due for release the week of October 18th
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