Never surrender: Fed fights failure with more of the same

The current policy of quantitative easing has had the opposite effect from what was intended, but the Fed is staying the course.

Susan Walsh / AP / File
Federal Reserve Chairman Ben Bernanke listens during a Nov. 23 meeting at the Treasury Department in Washington. Bernanke and colleagues gathered Tuesday, Dec. 14, for their last scheduled meeting of 2010, where they decided to make no changes to their current strategy of quantitative easing.

"Shoot, if you must, this old gray head,
But spare your country’s flag,” she said.

A shade of sadness, a blush of shame,
Over the face of the leader came;

The nobler nature within him stirred
To life at that woman’s deed and word:

“Who touches a hair of yon gray head
Dies like a dog! March on!” he said.

John Greenleaf Whittier, “Barbara Frietchie

It’s the Ides of December, if December has ides. Some months do. Some don’t.

Yesterday, we drove up to Frederick, Maryland. It is the site of the encounter – fictional – between Stonewall Jackson and an old woman. More on that, below…

But you’re probably wondering what the Fed’s FOMC did yesterday, aren’t you? You’re not? Well, good for you. You must have a life. Or a brain.

Those of us who are condemned to follow such things found out that the Fed is standing pat. You can imagine how that stirred our blood. We had barely slept wondering what the Fed would do. We had worn out the carpet, pacing back and forth. And now we discover that the Fed will do nothing!

The “recovery” is too weak to raise rates, said the Fed. And the economy may need more stimulus, it added; so it will stick with its plan to buy $600 billion worth of US government debt.

You’ll remember that the Fed purchases were supposed to drive down long-term interest rates so that mortgage borrowing and capital investment increased. But instead of falling, long-term rates went up.

On the surface of it, you might think the Fed chief would lower his head…and admit that his quantitative easing plan is a colossal failure. Since March ’09, he has committed an amount equal to more than an entire year’s output of the US economy to his QE initiatives. With so much of the nation’s treasure lost, you’d think he’d offer to slit his wrists…or at least resign. But that would just go to show that you’ve never studied modern macroeconomics. If you spent a few more years in school, maybe you too could begin to see that up is really down and black is actually white. The Fed’s actions will multiply the US monetary base by 4. Is it any wonder investors are getting suspicious of US dollar-denominated paper?

In theory, the Fed’s purchases of Treasury debt are absurd. In practice, they have backfired. So, the Fed will do more of them. Makes sense, right?

The US bond market could be signaling that it is headed the way of Greece, Ireland, and Lehman Bros. Who wants an IOU from someone who can’t pay it back? Once the selling begins, it is hard to stop. Interest rates go up, increasing the cost of financing for the debtor. Pretty soon, he can no longer fund his on-going expenses or make the payments on his debt. He is forced into bankruptcy.

Meanwhile, the latest numbers from Robert Shiller tell us that the US stock market is 33% overvalued. Our guess is that stocks will go down much more than that number implies. Markets tend to overshoot in both directions.

And the latest news from China tells us the Middle Kingdom could blow up at any time. Nearly half the GDP is spent on capital improvements (usually things that involve concrete and steel). It’s breathtaking to see it. But there’s no way you can make that many capital investment decisions without making some colossal blunders.

And from Europe comes a bleak and foreboding assessment: European banks have five times as much government debt as they did 3 years ago…and even US banks have nearly $350 billion worth of debt from Europe’s wave-washed periphery. Investors are selling off Spanish bonds; another chapter in the debt crisis could be at hand.

Dear reader, you are faced with a grave and dangerous situation. In front of you is the Valley of Death for investors.

America’s stock market could crash at any moment. Its bonds are slipping. Its homes are sinking. China could collapse into a heap. Europe could come unglued. Trade could fall off a cliff. Interest rates could rise everywhere. Another great depression could be coming soon.

And yet, CEOs are optimistic, says one report. Investors are overwhelmingly bullish, says another. And your captains are telling you to “charge ahead!”

Our advice: Take cover!

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