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The FOMC meets today to discuss
their record-low interest rate policy. The announcement of their decision
will be released on Wednesday. While no increase in interest rates is
expected, there is little doubt amongst investors that the future direction
for the central bank's target rate will be up. In fact, Kansas City Fed President
Thomas Hoenig has repeatedly expressed his desire for an increase in
overnight lending rates to 1 percent from the current zero-0.25 percent range
by the end of summer.
However, recent economic data
including; the Philly Fed Index, first time jobless claims, Non-farm payrolls
and retail sales are already pointing to a probable double-dip recession.
Therefore, the Fed's next move is more likely an ease rather than a
tightening of rates.
But the ease won't come in any of
the traditional forms. The Fed isn't going to reduce rates to a negative
level. Charging people to deposit their money into a bank just isn't going to
be politically palatable. Our central bank will also not seek to once again
dramatically increase the size of the Fed's balance sheet. Although the Fed
bought another $7.34 billion in Mortgage Backed Securities last week, even
Mr. Bernanke won't be foolish enough to buy up another $1.5 trillion of
assets that he will not be able to dispose of in the future.
The next ease
from the Fed will most likely be in the form of ceasing to pay interest on
excess reserves. Since October 2008, the Fed has been
paying interest on commercial bank deposits held at the central bank. But
because of Bernanke's fears of deflation, he will do whatever it takes to get
the money supply to increase. With rates being near zero and the Fed's
balance sheet already at an intractable level, the only viable solution to
fight Ben's phantom deflation fear is for him to remove the impetus on the
part of banks to keep their excess reserves laying fallow at the Fed.
If commercial banks stop being
paid to keep their money dormant, they will find a way to get money out the
door. They may even start shoving loans out through the drive-up window.
Banks need to make money on their deposits (liabilities). If the don't get
paid by the Fed, they will be forced to take a chance on the consumer. After
all, it has been made clear to them that the Fed and Treasury stand ready to
bail out banks' bad assets at any cost. So why not take the chance once
again?
The statement from this month's
meeting of the FOMC will probably not indicate that interest will no longer
be paid on deposits by the Fed to commercial banks. However, in the near
future this strategy will be the most appealing method for the Fed to
increase liquidity. Once Mr. Bernanke assents to the double-dip recession
scenario, he will fight deflation by any means necessary.
Deflation is not a possible
outcome if a central bank is willing to do whatever it takes to increase the
money supply. The fed can buy every house on the market if it so desired and
it could buy every dollar of our $13 trillion national debt. And while it is
true Bernanke can't force banks to lend, he can compel them to boost the
money supply by removing any compensation involved from keeping the money
multiplier in check. And even if there was no banking system or fractional
reserve system in place, it would be a specious argument to make that
inflation could not occur without having private banks involved.
According to Bernanke's academic
philosophy, expanding the money supply somehow equates to growing the
economy. In order to grow the economy credit must be available, but much more
importantly interest rates and the value of the dollar must be stable.
The current Federal Reserve
Chairman is a student of the Great Depression. Although he will,
unfortunately, most likely get a chance to study one first hand, this next
one will be marked by inflation rather than deflation. Investors should be
aware he will do whatever it takes to avoid a collapse of the money supply
and a double dip in the economy. Part of his plan is to ensure there is not
only plenty of money printed -- that much he has already accomplished in
spades -- but that banks are also well incentivized to loan it out.
Michael Pento
Senior Market Strategist
Delta Global
Advisors, Inc.
Delta Global
Advisors : 19051 Goldenwest, #106-116 Huntington Beach, CA 92648 Phone:
800-485-1220 Fax: 800-485-1225
A 15-year
industry veteran whose career began as a trader on the floor of the New York
Stock Exchange, Michael Pento recently served as a Vice President of
Investments for GunnAllen Financial. Previously, he managed individual
portfolios as a Vice President for First Montauk Securities, where he
focused on options management and advanced yield-enhancing strategies to
increase portfolio returns. He is also a published economic theorist in
the Austrian school of economic theory.
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