The Fed Sees Slow Growth Ahead

* The future of Fed moves was placed very prominently on the front page of today’s WSJ, which was titled “Fed Sees Slower Growth”. The article discussed the range of opinions of the Fed’s board members which split between wanting to consider more security purchases, quantitative easing or money printing, to counteract a slowing economy, while others think the Fed should just sit pat, and even consider ways to withdraw the excess cash the Fed has put into the system. And there is also a contingency which thinks that even if the Fed puts more money into the banking system, that it will have a negligible impact, at best, while raising concerns about inflation. 


For the record, I agree with the latter camp, that additional QE will have only a modest impact on the economy. The basic exception to this premise has to do with how the market responds if US interest rates start rising, due to concerns about the future budget deficits. In this case, I fully believe that it will be better for the Fed to monetize the deficits, rather than let the markets force a debt and currency crisis. In fact, in the late 1940s and early 1950s, the Fed did just this, and interest rates stayed low despite high inflation and high relative deficits; the Fed was monetizing some of our debt, and kept rising rate pressures away from the market. The Fed will never publicly say they will do this, because that would give Obama a license to run trillion dollar deficits as far as the eye can see. In the late 1940s/early 1950s, printing money did result in a bout of inflation, and I would expect the same to occur if the Fed monetized another $2+ trillion of the deficit. Yet such an outcome would only occur farther out in time, and after a couple years of monetizing debt. Eventually QE will enter the playbook as a way for the US government to circumvent the debt markets in an environment of rising rates amidst deflation.


The most hawkish member of the Fed’s FOMC, Kansas City Fed President Thomas Hoenig, was interviewed on CNBC this morning. Hoenig was asked about whether or not he thought that additional easing, which at this point in time, boils down to money printing/QE, would be necessary. Hoenig said that it all depended on what the administration did in terms of tax policy and taking positive action to reduce the deficits. In other words, Hoenig, who is the most hawkish amongst the Fed, thinks that the economy’s future path will be determined by what the administration and Congress will do. In other words, without specifically saying so, he thinks the Fed’s maneuvering room is diminishing. I agree with that conclusion. With rates near zero and long term rates at their lowest level since late 2008, there is little left for the Fed to do. No one is going to talk about monetizing debt to forestall rising interest rates, and a debt or currency crisis, but that is what I think the Fed will eventually be forced to do.


The other interesting comment from Hoenig is that he envisions slow economic growth because the US still needs to go through the process of de-leveraging. It was nice to see that the FOMC is cognizant of the deflationary headwinds buffeting our economy. Ultimately, this will give the Fed the latitude to print massive amounts of money. Of course, massive amounts of money printing will result in a bubble in other asset categories, which I often harp on. That will be the good news for precious metals under all scenarios, and positive for resources, assuming the world isn’t in a severe depression.


* In response to yesterday’s blog, a reader wrote in with this comment:


“Your blog appears to completely dismiss the Krugman point of view, which was also supported by Nouriel Roubini in his Financial Times article yesterday (Monday).


Deficit hawkery or tentative and/or insufficiently funded recovery programs will not solve any problems at this time and will lead us deeper and deeper into recession or towards depression. I thought the Japan lesson was that partial and insufficient recovery funding does not work. 


Yet it appears that your cited authors adhere to the deficit hawk school

of thinking. Politically, attacking the deficit sounds so conservative

and fiscally sound. 


Practically, bold measures are needed. We need to extend unemployment benefits, have the fed shore up the ailing state budgets (states cannot deficit spend and must have balanced budgets), get $ loaned to small businesses. Invest in upgrading the pathetically corroding and aging infrastructure. Invest in projects that encourageenergy independence. Or create incentives to business to invest in such projects. 


Want to get some big money into the system? Stop the biggest tax scam going, where the largest corporations in the world locate themselves in tax havens and pay no income taxes whatsoever. Yeah, I said it, tax business. 


Tax carbon. Tax sugar. Tax tobacco. Tax that which ultimately burdens the system with cost so as to promote and equal the playing field for the long-term goals that best serve the national interest.” (end of readers comment)


Well, Krugman and Roubini only says that we need to spend money, not on how the money is spent. To that I will add that we need to spend money on endeavors which create jobs, which in turn support other jobs. Giving states money, so they do not fire teachers is a waste, since the school systems are overburdened to begin with. The government should spend money to train the soon to be unemployed teachers, advanced skills so they can find a place in new businesses. The government should also spend money to subsidize the production of green products, like solar panels, which we are already subsidizing the purchase of by homeowners. This way, at least the production of these green products takes place in the US and not in China. 


By hook or crook, we are going to have to get our unemployed back to work. Dropping the minimum wage would go a long way to bringing jobs back to the US. I know this is unpopular, but eventually deflation is going to pull the prices of most products lower, so lower wages in this country might need to be what is needed. Why wait for more jobs to go overseas?


As for the taxation of various goods, like tobacco, excessive taxes will just push the retail sales of such products off the grid, so I am not sure how viable or productive that would be. As for taxing carbon emissions, this will hurt businesses and push jobs/new factories to countries which do not have the same tax policies, so again, I dis-agree with that idea too. As taxes on products rise, eventually the sale of these products will go under-ground, or the production will go overseas. There is a limit to how much taxes can be raised without having an adverse impact on the economy. I do not have pat answers to how much each such tax can be raised, but there are limits which should be considered before a race to increase taxes has a negative impact on these specific aspects of our economy.