By Mike Whitney
The US economy has been out of recession for more than 2 years. Last week, the Bureau of Economic Analysis (BEA) announced that real gross domestic product (GDP) had increased at a rate of 2.8 percent in the fourth quarter of 2011. Also, unemployment is slowly retreating, the output gap is gradually narrowing, and the President of the United States never hesitates to boast how the recovery is on course. So why did Fed chairman Ben Bernanke announce last Thursday that the Fed would freeze “the federal funds rate at 0 to 1/4 percent…..through late 2014″. Keep in mind, zirp (zero interest rate policy) was implemented purely as an emergency measure during the peak of the financial crisis in late 2008. Surely, things have improved since then, haven’t they?
No, they haven’t. At least that’s what Bernanke is saying by extending zirp for another 3 years. And, he may be right. Just look at the bond market. 3 years into the so-called recovery and 10-year Treasuries are still well-below 2 percent, which is to to say that there’s no sign of a credit expansion anywhere. And 5-year Treasuries are even worse. 5-year yields tumbled to a record low just last week more than 30 months after Bernanke announced an end to the recession. So, if the recession is over and things are getting better, then why aren’t consumers and businesses borrowing again? Money is as cheap as it’s ever been, but the supply of credit worthy customers seems to have dried up altogether. Why is that?
Of course, none of this is really that hard to figure out for those who follow the financial news closely. In fact, McKinsey Global Institute just released a report last week which spells it all out in black and white. The fact is, when ordinary working people are forced to cut their spending to reduce the amount of debt they’ve piled up, then economic activity and business investment slow down dragging the economy into a long-term funk. (McKinsey reckons America’s households are only between a third and halfway through this debt-reduction process.) The best way to resolve the issue, is to boost the government’s share of net-spending to keep the economy growing while consumers get their balance sheets back in order. That means Bernanke should be pushing congress to provide more fiscal stimulus to ease ongoing consumer deleveraging. More federal spending, means lower unemployment, more activity and bigger government revenues. Unfortunately, Bernanke is opposed to fiscal stimulus. He prefers unconventional policies (like quantitative easing) which boost stocks but also send commodity prices higher putting more downward pressure on consumer spending. This is just one of the unintended consequences of the Fed’s oddball policies.
So, is there any indication that the Fed’s low rate strategy is working?
No. Then why is Bernanke implementing the same policy?
And don’t think there isn’t a cost to zirp either, because there is. Just ask any retiree or pensioner who’s trying to scrape by on their fixed income investments. They’ll tell you that the low rates are killing them. Here’s how Edward Harrison sums it up on a post at Credit Writedowns:
“If you are an American retiree or near-retiree, you’re not happy these days. Five years ago, you were getting a decent return on your fixed income investments. But since then, the Fed has trashed the fixed income market by reducing interest rates to zero percent for “an extended period”. The thinking is that this will get people to take on more credit. But the reality is that a lot of people are stuffed to the gills with existing credit and are not creditworthy. The Fed is pushing on a string.
Meanwhile, it is sucking money out of the economy. Ross Perot would tell you that giant sucking sound is the fed reaching into your pocket and giving your interest income to the Treasury by buying up government debt and keeping interest rates at zero.” (“Permanent Zero and Personal Interest Income”, Credit Writedowns)
Bernanke is betting that the policy will stimulate enough borrowing to offset the losses in consumption by people living on fixed income investments. But that’s just a crap-shoot; he has no way of knowing for sure. According to the Fed’s own calculations–the interest payments that these savers are losing is somewhere in the neighborhood of $400 billion per year. That’s a lot of potential spending that’s being negated by the present policy. Bernanke could be just shooting himself in the foot.
Of course, zero interest rates can increase spending by lowering the cost of money, but that’s not a done-deal either. It depends on the situation. In this case, we’re dealing with a very specific, but unique phenomenon; a balance sheet recession, where consumers are more focused on minimizing debt than maximizing profits. These people are not easily seduced by low rates. What they want is less debt. Bernanke has a hard time wrapping his mind around this concept, which is why he keeps returning to the same worn refaltion techniques. As the saying goes; when all you have is a hammer, everything looks like a nail.
And that’s precisely the point. Bernanke can’t fix the problem because he doesn’t have the right tools. The Fed doesn’t have a transmission mechanism for delivering stimulus to the people who will use it to rev up the economy. British economist John Maynard Keynes figured this all out long ago. He understood that there are times when monetary policy just won’t get any traction and he wrote at great length about the policy alternatives that could be implemented to put the economy back on track. It’s all in his masterpiece “The General Theory of Employment, Interest and Money”. Maybe someone should get Bernanke a copy.