When the Federal Reserve announced last week that it would keep interest rates low until mid-2013, it did so despite the dissension of three Fed governors.
Yesterday, one of the dissenting governors, the Philadelphia Fed President Charles Plosser told Bloomberg radio that the Fed’s decision to keep rates low for another two years was "the inappropriate policy at an inappropriate time."
I was kind of surprised by this type of strong statement from a sitting Fed president. Most of the time, Fed insiders wait until they’re not inside the Fed before they start throwing mud.
Plosser also said that he doesn’t think the Fed will keep rates low until mid-2013. Maybe the other Fed presidents didn’t clue him in – that such a statement from the Fed is primarily intended to induce investors to pile into stocks again. They don’t really mean it. And they can always back out and raise rates tomorrow.
They’re not handcuffed or tied to any of the statements they make: they can literally say or do anything they want in order to keep up the appearance of a healthy market.
In fact, it’s their Congressional mandate to do so.
In 1977, the Congress gave the Fed a dual mandate of stimulating growth and jobs, as well as keeping a stable currency.
So on the face of it, this dual mandate seems to be the equivalent of telling your 12 year old son to build a roaring gasoline fire on the living room rug, but to be careful not to burn the house down.
Ironically, this 1977 mandate touched off one of the most inflationary periods in this country’s history – ending only when the Fed Chairman Paul Volcker infamously raised the Federal Funds rates to ridiculously high levels in the late 1970s and early 1980s.
Who can blame the Fed for either doing too much or too little? Their dual mandate is an obvious paradox.
And unlike the late 1970s, there’s no Paul Volcker waiting in the wings. Well, I guess Volcker is still around, but raising rates to the degree that he raised them back then would be suicide for the dollar.
It’s almost like a strange dream: Federal Fund rates actually hit 15% for a brief moment in 1982. That means that long-dated Treasuries were yielding even more.
But that ship has sailed. We no longer have the ability to fidget with monetary policy on the margins to increase output, to stymie inflation or to spur growth.
Simply put, we’re already up to our ears in interest payments on our debt. Raising the interest rates on our debt would hermetically seal the dollar’s coffin after nailing it shut.
It seems that the more the Federal Reserve tries to do, the less effective they are in doing it. That’s what Mr. Plosser says too – the Fed is "risking its credibility because it’s doing things that don’t work."
And that sentiment is exactly why people are losing faith in the dollar. The Federal Reserve is slowly being unmasked and discredited by its own policies. Investors are turning to other assets and starting to hoard commodities and purchase commodity investments.
The real problem is that the Federal Reserve governors, Plosser included, actually believe that the economy is a big blinking machine with pulleys, levers, buttons, shifters and turn signals.
They believe that all they need to do is depress the right levers at the right times, pull this pulley, push that shifter and signal correctly at such and such a juncture – and they’ll be able to actually control the speed and direction of the economy itself. Simultaneously, they’ll keep inflation in check.
What they constantly seem to forget is that the economy is not a machine. It’s much more complicated than they could ever correctly model for even a few hours let alone a few years.
And even if they were able to have their fingers on the pulse of every metric, statistic, and motivator in the markets, they still forget that unlike most machines, this machine learns.
When you push one lever (interest rates) over and over again, it has less and less of an effect. Eventually it stops working altogether.
The machine has now learned that the Federal Reserve plans to keep rates low for the foreseeable future. But the machine has heard this story before. And it’s not as quick to fall for it.
Maybe next time, the machine won’t care at all about any of the instructions it gets from the dollar or the Fed. It will move on to a system that does work, and isn’t dependent on PhDs in Washington DC for direction.