Susan Luzzaro 6:30 p.m., July 31
Fed Admits Things Worse; Will Squirt in More Liquidity
The Federal Reserve today (Aug. 10) finally admitted what Main Street has known for months: the economy is weakening. So the Fed's powerful Open Market Committee, which has already pushed short rates to near zero, shoved money at the big banks, and bought mortgage-backed bonds to drop mortgage rates to extremely low levels, vows that it will provide even more juice. It will reinvest the proceeds it receives from mortgage-backed securities in U.S. Treasury bonds -- hoping thereby to lower long term interest rates even more. Clearly, the Fed is signaling that it won't raise short rates any time soon and won't do anything to repair its very tattered balance sheet.
"The Fed is concerned about deflation (actual decline of prices)," says Ross Starr, professor of economics at the University of California San Diego. "I am more optimistic. They will not let the 1930s, or the Japanese 1990s, recur." There are stark similarities between the U.S. Great Depression of the 1930s and today, says Starr. "Back then, there was an immense amount of cash sitting unlent in banks and that is precisely what is happening now." Some economists worry that if the economy snaps back and the banks start lending heavily again, inflation will be ignited. But Starr thinks that if that happened, the Fed will have "plenty of time" to shift to a tighter monetary policy that would thwart inflation.
In my own opinion, the Fed's lending out money to banks for essentially zero rates is a danger, given the financial institutions' irresponsible behavior of recent years, as well as their still-phony accounting, by which their liabilities are concealed through offshore maneuvering. Also, in my opinion, the very low short rates punish savers, thus exacerbating the dangerously inequitable division of wealth and income in the U.S., whereby the wealthiest 1% corral a huge percentage of wealth and income. Not surprisingly, as soon as the Fed made its announcement, the stock market improved markedly. That's because markets these days respond to liquidity (low interest rates, money-printing, fiscal looseness) more than they respond to the state of the economy. This seeming paradox often puzzles people on Main Street who believe that the stock market reflects the state of the economy. That's only partly true. As the Fed feeds the big banks' trading desks money at 0%, both bonds and stocks rise. But the Fed only does so because Main Street is ailing. For the banks, it's like being staked by a sugar daddy at the poker table