Thursday, May 23, 2013

The Bernanke Box

Ben Bernanke is painting both himself and the Federal Reserve in a corner. With a policy of loose and cheap money  and an inflation target of just 2% the Federal Reserve  continues to please those gambling that not fighting the Fed guarantees profits. As many Americans are forced to pay higher food, gasoline, and health insurance premiums, I wish someone would let the Fed Chairman know we are already there. Any thought that inflation is not higher has to be from the false illusion brought from falling rents and mortgage payments, this is a one off and will not continue.

With reports of 20% pay raises for many factory workers in China over the last year, we can expect the cost of consumer goods imported from China to rise. America imports around five hundred billion dollars worth of goods from other countries every year then they export. We have a giant trade deficit, add to that our massive government deficit and it is easy to see that we are living far beyond our means. This means that Bernanke and the Fed  must soon begin to ponder the exit strategy and how they can remove the massive stimulus that the economy has come to expect.

Sadly little has been done to address our structural problems and make America more competitive, growth will be thwarted unless these and other issues are dealt with. The Fed Chairman has failed to take serious efforts in pushing the government to take the necessary reforms needed to move the economy forward.  What started as a program to support and prop up the economy has morphed into the main driver of economic data. Between the low interest rates that are forcing investors into high risk assets in search of a positive return on their money, and money being pumped into the system, the markets have become distorted and disconnected from the economy. The idea that the money will continue to be forced into the sky high equity market is flawed

The Fed is in a corner, with higher interest, mortgage rates will rise. The low interest rates that have discouraged savings and encouraged people to take high risks has also dampening bank lending. This does not lead to a healthy economy, but rather a story that will end in tears and regrets. When interest rates rise, as they will have to do at some point, the value of these risky investments will decline, and these investors will be hurt. Also as a double whammy, interest payments on the public debt will rise, increasing the budget deficit, which has been a trillion dollars a year for the past four years

If all the money dumped into the economy would suddenly change direction and rush into hard assets, the shift would be devastating to our struggling economy. This thought also raises other questions, what can we define as a hard asset, what is really available, and in what quantities? This may be where inflation raises its ugly head. A unknown and surprising fact about inflation is how fast it can take root. With such a shift, interest rates would move higher and investor would flee government bonds. The crash of the bond market and what many have called a Bond Bubble will become a reality. Coming up with a plausible exit strategy and making it work are two different things.

Footnote; This post dovetails with many of my recent writings, for more I might suggest reading the article below. Other related articles may be found in my blog archive, thanks for reading, your comments are encouraged,

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