Trapped: The Fed Has Painted Itself Into a Corner

Fed Chairman Ben BernankeAs prices for commodities such as cotton, sugar and grains skyrocket, many financial commentators have been pointing the finger at Federal Reserve Chairman Ben Bernanke's "easy money" policies of zero interest rates (ZIRP) and quantitative easing (QE2) as a major cause.

The Fed intended these two policies to lower long-term interest rates and to nudge investors into riskier assets, thus stimulating growth. At least one part of that strategy is working. By lowering the yields on traditional financial investments such as bonds to near-zero, the Fed has essentially forced trading desks and hedge funds to scour the globe for higher yields.

Many traders and investors have found that higher yield in commodities, which is where speculative money is now flowing in abundance, helping to push up prices. Because the price of wheat, for example, is roughly the same everywhere in a global market, these rapid price increases are destabilizing poorer countries where much of household income is devoted to food.

Charges and Countercharges

Global demand for many commodities is outstripping supply, and that imbalance is a key factor in higher prices around the world. But a global economy awash in low-interest, speculative "hot money" seeking higher yields is further fueling imbalances.

Fed officials have faced pointed criticism from nations such as China and Germany, which see the Fed's policies as firing up inflation and suppressing the U.S. dollar. Fed Chairman Bernanke has countered these charges by identifying the problem as one of currency valuations. He suggests that other nations should offset rising commodity prices by letting their currencies climb in value.

Bernanke's protests, however, have a hollow ring: Clearly, skyrocketing commodity prices aren't just a currency-trade issue. For example, consider this cotton-price chart, which has "gone parabolic." Can anyone seriously claim that the "solution" to this situation is for China to allow its currency, the yuan, to appreciate? Is the yuan the real cause of wheat and corn both shooting up 80% in 2010?



The reason why Bernanke's claim is so transparently nonsensical is that commodities are rising everywhere, not just those originating in China. Despite official assurances that inflation in the U.S. is now running at a modest 0.7% annually, by one measure, it's actually hitting an annual rate of 2.5%. By another, it's already a white-hot 10.6%.

This chart shows how rising prices are built into the supply chain, with the result being costs of intermediate and crude goods are rising smartly.



Inflation is running hot around the world, not just in China and the U.S. This also suggests that the issue isn't one that can be resolved with currency adjustments.

Even though inflation appears to be lower in the U.S. than in other major economies, it's hitting the average U.S. household hard because wages aren't rising along with prices. Indeed, according to the U.S. Census Bureau, real median household income in 2009 was $49,777, a 5% decline from the 1999 peak of $52,388 (adjusted for inflation).

This is in marked contrast to nations such as China, where workers are gaining substantial raises (21% in Beijing, for example), to counter rapidly rising costs.

An Unbreakable Cycle


The Fed is being disingenuous in claiming it's blameless for global inflation. And in a larger sense, the central bank is attempting to repeal the business cycle. In the normal course of capitalism, low rates and easy credit lead to increased borrowing, which leads to rising consumption and investment in production to feed that increased consumption.

This leads to higher profits, which generates more investment and credit expansion.

At some point, the cycle hits a brick wall: Borrowers can no afford to pay more interest as rates rise, so debt stops increasing, and consumption and demand slump as borrowing levels off. In the rush to mint profits, production capacity now exceeds demand. And as a result, prices and profits both fall -- the natural consequence of excess capacity.

As the boom progressed, investors sought out riskier, more marginal investments. But as new debt and demand fall, these riskier investments lose money and are either shuttered or sold for a loss.

Then, as profits decline, workers are laid off, and commercial borrowers find their income streams aren't sufficient to meet their obligations. The credit cycle turns from expansion to contraction, as marginal borrowers go bankrupt and insolvent businesses and loans are liquidated or written down.

This purging of bad debt, speculative excess and misallocated resources lays the foundation for another cycle of renewed growth.

Credit Goes to the Wrong Hands


But the Fed is attempting to repeal this business/credit cycle. Rather than allow credit to fall sharply and interest rates to rise as bad debt is purged from the financial system, the Fed has pursued a policy of making credit even cheaper in the hopes that borrowers will be able to borrow more since rates are near-zero.

However, because consumers and enterprises are still burdened with mountains of existing debt and undeclared losses, few are willing or qualified to borrow more. As I recently wrote here, consumer debt in the U.S. has declined a paltry 2.7% in the wake of the Great Recession.

The Fed's quantitative easing thus ends up flowing not to households or productive enterprises but to the "too big to fail" banks and Wall Street firms, which then seek higher returns in assets such as stocks and commodities. The Fed's intention was to push money into productive growth, but instead it has fed pools of speculative money chasing high returns in global commodities. This is helping to fuel inflation in food and other commodities -- not just in the U.S. but globally.

In a Double Bind


Now the Fed has painted itself into a corner. If it keeps interest rates low and continues pouring hundreds of billions of dollars into "hot money" hands, it will be adding to the destabilizing forces of rising commodity inflation. If it stops its QE2 stimulus to help cool global inflation, then interest rates will rise, pushing marginal borrowers out of the market and increasing borrowing costs for everyone from new home buyers to Wall Street speculators. That could destabilize the fragile recovery and the bull market in stocks.

By attempting to repeal the business cycle and refusing to allow a necessary credit cleansing (writing off of bad debt) and repricing of risk, the Fed has created an inescapable double bind for itself: either continue pursuing easy-money policies and help destabilize the global economy with rising commodity inflation, or allow interest rates to rise and destabilize speculative markets and marginal borrowers.

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Dereck

Major Fraud Alert


The entire Federal Banking System under FirstGov has been "Consumed" and "Levied" by way of a Maryland State Circuit/District Court Ruled “Appropriation and Garnishment” of all Future Earnings prior to and after 2004 against Bank Of America by way of the F.D.I.C. Regulations Prohibiting failing Banks from Merging with other failing Banks between the Dates of 08/04/08 and 10/09/09.

Bank of America violated the 21st Century Act: Final Amendments to Regulation CC Section: http://www.federalreserve.gov/boarddocs/press/bcreg/2004/20040726/attachment.pdf

seeking reimbursement of Credit, Loan, and Finance Balances as a "Bank Entity" and not a "Nonbank Consumer" as specified on Pages 85 and 86.

The person they sued through a LLC. Debt Collection Company and Law Firm was the "World Fortune Owner" who "Counterclaimed" and won.

Now all Contracts of any Corporations (Including Employment) under the "Controlling Interest" of any Investment Bank Worldwide are "Null and Void", and are also under the stipulated Rules and Regulations of an "Closely-held S Corporation rendering all Employed under Legal Actions against “Domination”, and also means that "No Corporation can hold Shares" officially making every Stock Exchange on the Planet a "Ponzi Scheme" by default.

Businesses owned by the States (Public Corporations) are being sold Stock Shares by Corporations also under the Federal Banking System in this Worldwide "Ponzi Scheme". The World Fortune Company Merrick Inc. Sweden is dissolving Millions and Billions of Dollars from "All Levels of Government"in the U.S. of Financing based upon Years of "negligent inaction" involving this case.

The Federal Government has already been forced to discontinue supplying the Financing States use to pay their debts, Persons in Government Offices may want to begin to take their jobs more seriously, these are different times from 10 Years ago and you will not be accepted civil servants here just because you say you are here to do the right thing.

May 29 2011 at 1:10 AM Report abuse rate up rate down Reply
caohellsux1978

The world's largest publicly traded company on Thursday reported net income of $10.65 billion, or $2.14 per share, in the first three months of the year. That compares with $6.3 billion, or 1.33 per share a year ago. Revenue increased 26 percent to $114 billion.

The results surpassed Wall Street estimates of $2.04 per share on sales of $112.6 billion, according to FactSet.

The quarter was Exxon's best since it earned a record $14.83 billion in 2008's third quarter. It comes at a time when some drivers are paying $4 or more for gas and President Obama is threatening the oil industry's multibillion-dollar tax subsidies.

Earnings grew across the company's business segments. Income from its exploration and production business gained 49 percent to $8.7 billion while the company's downstream business, which includes refineries, posted a huge 30-fold jump to more than $1.1 billion.

Anticipating a strong reaction to the results from drivers and politicians, Exxon said on a company blog Wednesday that it has little control over the price of oil, which has risen to near $113 per barrel. The company also noted that less than 3 cents of every dollar it earns comes from the sale of gasoline and diesel fuel.

Now, are you still going to blame the Middle East?

BOYCOTT EXXON/MOBIL NOW THROUGH JULY THE 4TH. BUY YOUR GASOLINE ANYWHERE BUT EXXON/MOBIL, OR ONE OF THEIR MOM AND POP STATIONS. BOYCOTT THEM, AND CUT INTO THEIR PROFITS AND THEY WILL HAVE TO LOWER PRICES.

April 29 2011 at 8:36 AM Report abuse rate up rate down Reply
Darrell & Donna

Too bad Bernanke is another Greenspan;;He screwed this country up big time;taking care of wall street;;Do away with the feds;;

February 28 2011 at 7:31 PM Report abuse rate up rate down Reply
Sonny

Sit on your cash folks............higher interest rates are just around the corner. Either that.......or hyperinflation. Surely the Fed won't let hyperinflation happen. Watch the banks start squealing when they have to pay a higher interest rate on your savings. But also be aware that the inability of the govt to reduce spending could cause a financial disaster...........in that case, your money is gone and it really doesn't matter anyway...........whoopeeeeeeee

February 25 2011 at 10:09 AM Report abuse +5 rate up rate down Reply
sdwcorp

Solutions can be devised the problem is getting concensus, Whats legal ,will people ,and politicians give in to big change?

Posibilities for solutions:

Open up all avilable oil exploration and drilling , Tell the companies do what you must ,however you will be held accounatabl for envioremental damages.

Change trade agrements Give them the same deal; they give us!!

Deport ILLEGAL immigrants and\or Fine any employers $100,000 for hiring illegals

Make a policy to return jobs to america ,we want Americans answering our questions when we call the bank!!!!!

State Governments can get federal Government guarantees for bonds after putting into law in their states budgets and policies to keep debt under controle :this would take the form of controle boards made up of qualifed people.

Americans will have to take Jobs that get their hands dirty ,It will give them character.

Bad speller but good thinker Thank You Steve

February 25 2011 at 9:19 AM Report abuse +4 rate up rate down Reply
David

In the long run, the bubble of population growth will result in shortages and global poverty. In 1960 there were about three billion people on earth. Now there are seven billion and it's projected that there will be nine billion by 2045 (source: National Geographic Magazine). An alarm bell needs to go off, but those with their heads in the middle ages seek to thwart family planning and any measures that might slow the impending crisis. Of course business interests mostly want growth of population which just ensures that nothing will

February 25 2011 at 9:01 AM Report abuse +2 rate up rate down Reply
2 replies to David's comment
David

be done.

February 25 2011 at 9:02 AM Report abuse -1 rate up rate down Reply
Sonny

It is God's plan...........any attempt to change his plan will result in a miserable failure..............when will you learn?

February 25 2011 at 10:11 AM Report abuse rate up rate down Reply
jelder5900

Don't hear too much about the harm this low interest rate thing is doing to savers and retirees. In addition there is pressure to cut Social Security. I wouldn't feel so bad about cutting my SS if the government wasn't using taxpayer debt to subsidize wall street bankers! Think about it people.....keeping rates low to help Goldman Sachs and JP Morgan Chase is killing us retirees.

February 24 2011 at 11:10 PM Report abuse +4 rate up rate down Reply
wolverineent

unfortunately the big hole in your argument lies in the fact that rapidly increasing numbers of people are doing what you seem to advocate-raising food, canning/freezing, keeping chickens for meat & eggs doing for themselves and cutting back. and government's answer to self-sufficiency? ever-increasing regulations purported to protect us from dangerous food contamination-but serve only to restrict and regulate self-sufficiency and give a pass to the corporations that were the source of contamination of the food supply and resulting illnesses....and those same corporations responsible wrote the new bills for government to rubber-stamp. bills and regulations that **surprise** favor corporations and restrict small businesses and individuals.

February 24 2011 at 6:33 PM Report abuse +6 rate up rate down Reply
1 reply to wolverineent's comment
chvemn

sure is nice to see people understanding whats going on, hopefully enough will wake up before its to late

February 25 2011 at 11:05 AM Report abuse +3 rate up rate down Reply
I Made This

Very informative and understandible article. Wish you had the answer at the end of it Mr. Smith, if there is an answer to the mess.

February 24 2011 at 6:11 PM Report abuse +1 rate up rate down Reply
N68Firebird

The only "corner" that is problematic is occupied by consumers who are entranced by marketing ploys and a need to "buy, buy, buy!" I don't see where Bernanke is at fault there. Plus, another few questions: (1) How many readers know how to cook a simple healthy meal for themselves and any family members in the household, using fresh goods? (2) How many readers know how to fix a flat tire, change the oil, change an air filter, flush the radiator in their vehicle(s)? (3) How many readers know how to sew and repair torn clothing (or have a sewing machine to help them out with that)? (4) How many people have a clue how to grow their own crops whether in the ground or in pots, for their own consumption? These are some simple, easy household maintenance activities that can save people a LOT of money. But, then again, if people do these things themselves, they aren't paying businesses to do them. It's starting to sound like "Blame Bernanke" is starting to replace "Blame Bush".

February 24 2011 at 4:48 PM Report abuse +2 rate up rate down Reply
1 reply to N68Firebird's comment
wolverineent

oops, posted above instead of replying to firebird
unfortunately the big hole in your argument lies in the fact that rapidly increasing numbers of people are doing what you seem to advocate-raising food, canning/freezing, keeping chickens for meat & eggs doing for themselves and cutting back. and government's answer to self-sufficiency? ever-increasing regulations purported to protect us from dangerous food contamination-but serve only to restrict and regulate self-sufficiency and give a pass to the corporations that were the source of contamination of the food supply and resulting illnesses....and those same corporations responsible wrote the new bills for government to rubber-stamp. bills and regulations that **surprise** favor corporations and restrict small businesses and individuals.

February 24 2011 at 6:35 PM Report abuse +1 rate up rate down Reply