classical economics
for analysis,  forecasting
and policy design

Double Trouble Economy

By Wayne Jett
© January 31, 2008
    The Federal Reserve’s funds rate is better at 3% than at 3.5% as it was before the Federal Open Market Committee’s action on January 30. But the funds rate at 3.00% is “good” only relative to the “bad” rate of 3.5% or the “worse” rate of 5.25% in 2007. A “better” funds rate would be 2% and the “best” funds rate would be determined by the markets operating freely, which would be about 1% presently as the yield curve adjusts to normal.
    But the Federal Reserve insists on manipulating the funds rate to manage the cost of bank credit. When the FOMC changes the funds rate, commercial banks change their “prime rate” by the same amount, except that their prime rate is 3% higher. This is an attempt at central planning and control of the economy, and it is very harmful to the U. S. and global economies.
Credit Stresses from Inverted Yield Curve
    Ongoing credit stresses in economies around the world can be traced back to central banks – primarily the Federal Reserve – that have manipulated bank credit costs by creating an inverted yield curve. The inverted yield curve is a serious anomaly that free markets would not permit; yet the Fed presumes it can be imposed on the markets without significant impacts. In this instance, as always, market participants act to their advantage according to perceived conditions. When the cost of bank credit it pushed higher than the markets determine is reasonable, bank credit is effectively denied, and economic activity markets would ordinarily do is prevented. This is economically harmful action by the central bank.
    This is what the Federal Reserve has done for the past year and a half, and continues to do. Why? The Fed and its apologists say the funds rate was raised to invert the yield curve in order to curb “inflationary pressures.” By raising the funds rate, they argue, aggregate demand will be reduced, slowing production and raising unemployment. This, they contend, reduces inflationary pressures that would otherwise come from demands for higher wages and more consumer goods from working people. Put people out of work and they are not so demanding, although it costs the price of handouts.
Monetary Policy Causes Sub-prime Mortgage Crisis
    In August, 2007, I wrote that this Fed policy caused the sub-prime mortgage crisis by intentionally destroying jobs held by people who live in homes financed by sub-prime mortgages. These are precisely the people whose employment exists at the margins of the economy. Raise credit costs to slow production, and theirs are the jobs that get cut.
    The Fed does this purposely, so one might expect the Fed governors to step up candidly and accept responsibility. After all, this is professed monetary policy practiced by the most powerful central bank in the world. To the contrary, however, the Fed is nowhere to be seen when it comes to explaining to the president or to Congress that throwing sub-prime mortgage borrowers out of jobs is really their intention, and their policy is “working” in the sense that many sub-prime borrowers have lost their jobs.
    This is confirmed in recent analysis by Standard & Poor’s chief economist David Wyss, who reported last week that payroll and unemployment statistics are far more significant than interest rate resets in producing mortgage foreclosures.  Wyss found that only 2% of mortgage foreclosures in 2007 were caused by interest rate resets under adjustable rate mortgages, according to data released by Countrywide Financial. Yet 60% of mortgage foreclosures were due to loss of jobs! Way to go, FOMC!
    Politicians, economists and pundits ought to think about that before announcing through the media that a lot of people took loans they couldn’t afford to repay, or that greedy mortgage lenders made loans to people they should have known were dead-beats. Try walking in the shoes of those who are pawns of U. S. monetary policy presently imposed by Fed central planners before jumping to such over-broad conclusions.
Stimulus Package “Earmarks”
    Indefensible monetary policy is one of the two major problems troubling the U. S. economy and the financial markets. The other problem is fiscal policy, meaning taxing and spending by the federal government. The ever-present and growing threat is existing law that will automatically raise tax rates very significantly at the end of 2010 unless the law is amended. As the November elections approach, the markets become more convinced of the likelihood that this ax to economic growth will actually cut deeply into the nearly 40% growth in GDP experienced since the May, 2003, tax cuts.
    This concern grows by the day. It will be made worse, not better, by passage of the irresponsibly cobbled-together “stimulus package” that is really nothing more than another exemplification of out-of-control “earmarks” by Congress. Let’s “earmark” checks to millions of individuals in various political constituencies and call the payments “tax rebates,” regardless of whether the individuals paid taxes or how much taxes were paid. Just be sure the checks are in the mail by the time Congress recesses for campaigning before the November elections. Earmark $150 billion for these “pet projects” of getting representatives and senators re-elected, while incidentally creating an excuse that Congress cannot “afford” to extend the 2003 tax cuts beyond 2010.
No-Confidence Vote on U. S. Policies
    This is why markets and Americans are uncertain the economy is sound. The United States has completely irresponsible monetary and fiscal policies. U. S. policies are driving the global economy into the ditch, along with our own.
    Stop the tax rebate earmarks. Extend the existing tax rates indefinitely. Float the Fed funds rate. Stabilize the dollar relative to the price of gold by managing liquidity towards that objective. As the Fed proceeds to insist that the dollar price of gold has no significance to its currency, other central banks are discretely moving to build gold reserves instead of dollars. Every producer of oil or any other product knows why, but apparently Fed theoreticians do not. Just giving the point a little thought could be beneficial to all. ~