Here It Comes: The Fed Knows
February 20th, 2013
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I usually do a fairly-exhaustive post on the Fed Minutes.
There’s no point this time, unless you want to be bored (or amused), soÂ I’ll simply focus on the part that matters.
Policy was also aimed at improving the labor market outlook. In this regard, several participants stressed the economic and social costs of high unemployment, as well as the potential for negative effects on the economyâ€™s longer-term path of a prolonged period of underutilization of resources. However,Â many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possibleÂ complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability. Several participants noted that a very large portfolio of long-duration assets would, under certain circumstances, expose the Federal Reserve to significant capital losses when these holdings were unwound,Â but others pointed to offsetting factors and one noted that losses would not impede the effective operation of monetary policy.
Let’s lay it out there for you folks.
The Fed has a “line in the sand” beyond which they takeÂ actual capital lossesÂ on their portfolio.
If rates rise they get rammed from both front and backÂ as the payment of interest on excess reserves will force them to pay out coupon on funds at the same time the capital value of their assets will decline in ratable proportion to the duration and size of its portfolio.
This isÂ notÂ prospective or speculative.Â It is mathematically known and factual.
It has been known since The Fed began its intervention.
You have frequently, over the last few years, seen me post about the pincer of mathematics that closes the door on your neck when you try to play with exponential functions andÂ ignoreÂ the fact thatÂ all exponential functions eventually run away from you and blow up in your face.
The market has completely ignored this fact forÂ the last four years, and worse Ben Bernanke hasÂ repeatedlyÂ made statements like “The Fed will not monetize the debt” (while doing exactly that) and arguing other such nonsense such as “we must normalize our finances in the medium term” (five years ago, which means thatÂ todayÂ is the “medium term”!)
The reason it hasn’t happened is thatÂ CongressÂ has learned that it can “goose” GDP and thus the appearance of the economy’s health by spending money it doesn’t have, goading The Fed into “buying” those bonds with raw emitted credit.
But let’s recap what happens when you do this.
Let us assume there are 10,000 units of currency and credit in the system, and 10,000 units of output.Â Â You must not denominate the output in units of currency because if you do then you’ve created an open fraud in your claimed statistical figures, so let’s denominate them inÂ hours of labor.
So now I can exchange one hour of labor for one unit of currency or credit.
Now the government wants to “goose” the economy, and itÂ convincesÂ The Fed to emit 10,000Â moreÂ units of currency and credit.Â Â Note that the amount of output does not change in the immediate sense,Â and may not change at all!
But what does change is that each unit of currency and credit now only buysÂ one halfÂ of an hour of labor.
Of course thisÂ is a simplistic example.Â In the real world some people find ways to use leverage toÂ convinceÂ people that “profits will rise”, and stock prices go higher.Â They seem to be rather happy with this state of affairs.Â And some people may, seeing all this “money” (really credit) flying around, that they should hire more people and build more things.
But there’s a problem –Â the guy working for a living has to pay more for his gas, food and medicine, and his salary hasn’t gone upÂ as the amount of effort he is delivering into the economy hasn’t changed.
He is poorer in terms of what he can buy.
To whom do you think all those businesses that are going to make “record profits and expanding margins” are going to sell their products and services?
So why wasn’t the feedback immediate and devestating?
Ask yourself this –Â what happened to keep colleges from instantly going bankrupt when they doubled their tuitions or more within a few years?
That’s right — you give people that “credit” — that is, debt.Â You allow them to defer paying.Â Â ButÂ by doing this you make the problem worse, whether the credit is issued to the government, to a kid in college or to you buying a car or medical care, because what you’ve done is createdÂ false demandÂ for which nobody can pay without your “cheap credit.”
That, classical economics tells us, causes price to rise because demand expands.
And now I can’t pay for college without that credit at allÂ but you haveÂ intentionallyÂ made it necessary for me to access and use that credit to maintain my standard of living!
What happens when I can’t absorb any more debt — when that exponential expansion runs into the hard wall of economic output and people’s ability to pay?
The system crashes.
As it did in 2000Â when the government willfully and intentionally ignoredÂ hundredsÂ of bogus IPOs and outrageously “rosy” (and mathematically BANKRUPT) projections of “profits” for Internet companies that ultimately were proved false by the dozens.
As it did in 2007Â as a consequence ofÂ a housing bubble thatÂ The Congress and Fed manufacturedÂ on purposeÂ after the Tech crash in 2000.Â The government then went on to shield and protect both The FedÂ and banks, along with itself, fromÂ anyÂ consequences of its own intentional acts, whileÂ youÂ got screwed (again.)
And now as we are running into the wall again with medical, educational andÂ governmentÂ spending in 2013.Â
THE RECOGNITION THAT THIS PATH WON’T WORK BECAUSE IT CAN’T BY THE MARKET HAS BEGUN.Â IT HAS BEEN SERIALLY RUN TWICE PREVIOUSLY WITH THE INTERNET AND HOUSING BUBBLES AND HAS SERIALLY FAILED TWICE!Â EVERYONE INVOLVED IN DOING IT, FROM THE PRESIDENT TO CONGRESS TO THE FED, KNOWSÂ DAMN WELLÂ THAT IT WON’T WORK BECAUSE IT HAS NOT IN THE PAST — ANYWHERE IN THE WORLD — EVER, BECAUSE ITÂ CAN’T.
You’re seeing the start of what happened in the early part of 2007, and rather than address this head-onÂ our government is going to the exactly wrong thing and refuse to address it, and as a consequence we’re going to get another collapse into already-depressedÂ and therefore non-functionalÂ intervention capacity on the part of government and The Fed.
To Congress, Obama and The Fed:
Delivered by The Daily Sheeple
Contributed by Karl Denninger of Market Ticker.
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