This article was first posted at GoldMoney
FEDging the figures
2012-JAN-28
Both
the US Federal Reserve and the European Central Bank are
now offering limitless quantities of new money – the ECB
to support the banks, and the Fed for reasons (despite
explanations) that are not entirely clear. The Fed in
its press release announced that it expected interest
rates to “warrant exceptionally low levels for the
Federal Funds Rate at least through late 2014.” The fact
that the central banks governing the two most important
currencies in the world are issuing money to all-comers
at very little interest cost for up three years has not
been lost on gold and silver, whose prices shot up in
response to the Fed’s announcement.
The Fed has effectively extended its zero interest rate
policy (ZIRP) for another 18 months. The reason stated
is “low rates of resource utilisation and a subdued
outlook for inflation in the medium run”. More important
perhaps and unsaid is the presidential election due
later this year and the need to finance a deficit that
seems impossible to cut.
The Fed is running huge risks with its extended ZIRP,
principally with monetary inflation morphing into price
inflation. To help achieve its low inflation target the
Fed uses the Personal Consumption Expenditures Price
Index (PCEPI), which assumes that consumers switch
spending from higher priced goods to those that are
stable or falling. The result is that this index rises
at about one-third less than the Consumer Price Index,
which itself rises at less than half the CPI calculated
on the more honest methodology used before 1980. The
upshot is that the Fed uses inflation targets that are
so heavily adjusted that they are effectively
meaningless.
To the Keynesians at the Fed, subdued inflation is
linked with a sluggish economy, and here the Fed is very
selective in its approach. It admits that employment is
picking up, and household spending “continues to
advance”; but instead chooses to worry over slowing
fixed investment and a depressed housing sector. Surely,
whatever your views, there are enough signs of economic
stabilisation to justify sitting on the fence, instead
of committing to ZIRP for an extra 18 months.
I take the view that Gross Domestic Product is likely to
surprise on the upside, as I
wrote in an article for GoldMoney on 10 January. In
that article I gave concrete reasons why, and suggested
that money will begin to flow from capital markets into
the economy. This is important, because GDP is only a
money quantity and can rise without any underlying
economic progression – the difference being reflected in
the prices of goods and services. So GDP can actually
rise with no underlying improvement in economic
activity, it merely reflecting higher prices.
Changes in the prices of goods and services are actually
impossible to measure and so cannot be quantified.
Under-reporting price increases by using an index
approximation such as the GDP deflator, which represents
price inflation similarly to the PCEPI, artificially
inflates real GDP. It will be interesting to hear what
excuse the Fed comes up with then for the continuing for
even longer with ZIRP. The reality is that the Fed and
other central bankers are cornered and have only one
tool left: issue as much paper money as it takes to
prevent systemic financial calamity. This realisation is
only just dawning on individuals with savings to
protect, which is why precious metals were right to rise
so sharply.
