The Fed is
becoming more concerned about the sustainability of the U.S. recovery, just
as the economy looks to be gaining momentum. The unemployment rate has
dropped from 9.4% in December of 2010, to 8.5% twelve months later. The
American economy has added 1.5 million jobs over the past year, according to
the establishment survey of employment, while the household survey shows we
have averaged a monthly gain of 230,000 jobs over the past six months.
Meanwhile, the average work week and hourly earnings also showed improvement
in the December Nonfarm payroll report. In addition, Gross Domestic Product
has increased for nine consecutive quarters and is anticipated to post just
under a 3% annualized growth in Q4 2011, up from 1.8% during the prior
quarter.
So what was
the Fed's reaction to this ostensibly better news? San Francisco Fed
president John Williams told the WSJ in an interview conducted after the
December's NFP report release that the central bank will have to buy more
mortgage related bonds and that interest rates would not increase for a very
long time. Here is his quote, "Unemployment is going to be sustained
above a reasonable estimate of the natural rate of unemployment, which is
closer to 6.5 percent than the 8.5 percent that we have now. That does make
an argument that we should have more stimulus."
William
Dudley, president of the Federal Reserve Bank of New York, also detailed
several proposals to revive the US property market in a recent speech. His
plans included a principal reduction for borrowers, eased refinancing terms
for homeowners who owe more on their mortgage debt than their homes are
worth, and a US taxpayer-funded program to extend financing to unemployed
borrowers. Mr. Dudley gave his reasoning for more central bank easing last
Friday by saying, "The outlook for unemployment is unacceptably high
relative to our dual mandate and the outlook for inflation is moderate."
Sarah Bloom Raskin, a member of the Fed's board of
governors, added this weekend that forcing major banks to cut mortgage
principal as a penalty for poor practices was an option, "that should
stay on the table".
And now, as
unbelievable as it sounds, the individuals who are supposedly responsible for
preserving the value of our currency are close to adopting a specific
inflation target for the rate of its depreciation. James Bullard, president
of the Federal Reserve Bank of St. Louis, said late last week, "We are
very close to having inflation targeting in the U.S." Why isn't it
obvious to members of the FOMC that the target rate of inflation should be
zero?
But there are
many problems with having an explicit target for inflation. One of those is
which inflation metric will the Fed decide to use. The most likely
measurement of prices the Fed would utilize is the core rate of the Personal
Consumption Expenditure Price Index (PCEPI). But this measurement not only
excludes energy and food price increases but it has also, historically
speaking, produced much lower inflation numbers than the Consumer Price Index
(CPI). For example, the PCEPI for the third quarter of 2011 increased at an
annual rate of 2.3% and the core rate increased slightly less at 2.1%.
However, the CPI increased at an annual rate of 3.1% during the same time
period. In fact, headline PCEPI has historically run about 1/3 less than
overall CPI.
What's even
worse is the Fed uses the core rate of PCE, which is a chained weighted index
that excludes the things that Americans need to survive on a daily basis.
Therefore, the real rate of inflation suffered by most Americans will be
significantly higher than the rate the Fed is targeting. The reality is that
the Fed is now stepping up their easy-money rhetoric, despite the fact that
they have conducted a more than four year campaign to produce a higher rate
of inflation and lower the value of the dollar.
Both the Fed
and markets (the yield on the Ten Year note is under 2.0%) have dismissed
this recovery and for good reasons. Bernanke's Fed has decided to ignore the
better economic news and to continue its assault on our currency, the middle
class, savers and those living on a fixed income. He understands that the
European debt crisis is one that rhymes with the credit crisis of 2008, and
will dramatically lower the rate of GDP growth in the U.S. during 2012. But
the more important reason is that the U.S. has now accumulated more debt than
our tax base can support.
Our debt now
exceeds the total of our GDP and the annual deficits pile on an additional
$1.3 trillion each year to that accumulated debt. Our publicly traded debt
has increased 100% in the last 5 years alone! What is even worse is that our
debt as a percentage of revenue is exploding. Back in 1971, the national debt
was 218% of revenue. Back in the year 2000, that debt as a percentage of
revenue had grown to 280%. Today, it has skyrocketed to 700% of revenue. Our
government simply cannot survive having that much debt in relation to
revenue.
The worst is
yet to come because interest rates are now at an all-time record low. The
average yield on U.S. debt is near 1% today, but it was 6.5% in the year
2000. And given our record level of debt and Fed-led money creation, yields
on Treasuries could and should go much higher than at any other point in U.S.
history. How easily can the U.S. service our $15 trillion--and rapidly
growing--national debt if interest rates rise just a
few 100 basis points? Only imagine what would happen if they rose to where
yields on Italian or even Greek debt is today.
That's why
the Fed can't raise the over-night lending rate between banks. And they will
fight with everything they've got not to allow market-based interest rates to
rise on the long end of the curve either. Therefore,
our central bank deems it necessary to encourage an onerous level of
inflation to exist in the economy in an effort to grow nominal GDP and
increase tax revenue. Of course, their strategy is doomed to fail like every
other attempt at inflating the problem of too little revenue away. That's
because a central bank cannot control long term interest rates forever.
American citizens can only hope Bernanke's Fed learns that lesson before our
foreign creditors view U.S. debt in the same light as Greece.
Michael Pento
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