Tuesday, December 16, 2008

Fed Comes to Debtors' Rescue

The Fed announced today that it will allow its target rate to reach zero percent.

[Click on the image for a larger version of my latest cartoon.]

Up until now, the Fed has tried to bend its legal parameters just enough to absorb some of the bad debts of our banks and financial institutions in exchange for good credit, in order to prevent what they fear would be an economic crisis. (And for the moment, these are just fears.)

Today they announced that they will proceed forward with their intention to buy Treasuries outright, in an effort to replace the credit they think we are desperate for.

From today's statement:

"As previously announced, over the next few quarters the Federal Reserve will purchase large quantities of agency debt and mortgage-backed securities to provide support to the mortgage and housing markets, and it stands ready to expand its purchases of agency debt and mortgage-backed securities as conditions warrant. The Committee is also evaluating the potential benefits of purchasing longer-term Treasury securities."

Just as debtor nations have done in the past, the USA has once again decided to turn on the printing presses to save debtors. From my understanding of this commentary by Walker Todd of the American Institute for Economic Research, or of this one, the steps the Fed is about to take are inflationary. The Fed seems to be doing what it can to fight deflation through inflating the money supply, a counterproductive measure at best.

What the Fed should be (and probably is) afraid of is not so much deflation per se, but rather a deflationary spiral that causes fragile yet economy-essential entities to collapse. The problem is that they can't act on the deflationary spiral without stopping the deflating itself.

They will end up artificially propping up already inflated bubble-prices that are trying to right themselves through the deflating process.

Something I think we all forget is that when prices go down (i.e. deflate, in the loose sense of the term), we all get richer. When gasoline, bread, meat, lettuce and rice get cheaper, our purchasing power increases.

Inflation does the opposite. It favors debtors and makes the rest of us--and even the debtors themselves--all the poorer by decreasing our purchasing power relative to our income.

When you have an inflating of the money supply in a deflationary environment, you get the equivalent of a bubble under the surface, i.e. an unstable propping up of prices concomitant with the reduction of real wages.

Inflating may save the debtors, but it will only do so through the impoverishment of all of us.

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