Great Depression Online Archive Issue:

Curing Patients with Daffy's Elixir

Great Depression Online
Long Beach, CA
February 23, 2010

Inside This Issue You Will Discover…

*** Discount Rate vs. Federal Funds Rate
*** The World is a Wild and Wacky Place
*** Curing Patients with Daffy’s Elixir
*** And More

Discount Rate vs. Federal Funds Rate

The Federal Reserve raised the discount rate last Thursday to 0.75 percent.  The discount rate is the rate that banks pay to borrow money from the Federal Reserve.  And this rate had been near zero for over a year.  That means banks have been able to borrow money from the Federal Reserve for practically free over this time.

The word from the Fed is that the discount rate increase is mainly symbolic and that it won’t impact interest rates paid by consumers and businesses in the near future.  In other words, just because the Federal Reserve raised the discount rate, they don’t intend to raise the federal funds rate anytime soon.

The federal funds rate – the rate banks charge each other for loans – is important to watch because it’s used as a benchmark for interest paid on credit cards, mortgages, and business loans.  When the federal funds rate is increased interest rates generally follow.

~~~~~~What’s Coming Next~~~~~~

The stock market bounce is temporary.  The calm before the storm.  What will soon follow is a prolonged downturn.  A shakeout deeper, more severe, and more far reaching than anything we’ve seen so far.

Now, a depression may sound like bad news.  But actually, it isn’t.

How to Prosper in a Downturn 

~~~~~~~~~~~~~~~~~~~~~~~~~

Bond King Bill Gross told CNBC on Friday that he thinks the Fed won’t move the federal funds rate for at least six more months. 

Even so, do market’s care if the federal funds rate hasn’t yet been raised?  Thus far, the answer is maybe.  On Thursday, the day of the discount rate increase, Ten Year Treasury yields spiked from 3.73 all the way up to 3.81 percent.  Then, on Friday, they relaxed their way back down to 3.78 percent.  Yesterday yields rose to 3.79 percent.

The World is a Wild and Wacky Place

Tomorrow and Thursday, Federal Reserve Chairman Ben S. Bernanke, in his semi-annual report to the House and Senate, is expected to repeat to Congress that the federal funds rate will remain low “for an extended period.”

Regardless, mortgage and business rates could go up sooner than Bernanke and bond fund managers like Bill Gross want or expect.  What’s more, the perception they actually have control of these things could disappear faster than Harry Houdini from the Upside Down Water Torture Cell.

Last week it was revealed that China is no longer the largest foreign holder of U.S. debt…

“China may be back in second spot among the largest foreign holders of U.S. Treasuries,” reported the Wall Street Journal.

“Data out Tuesday in the U.S. showed China was a major net seller of Treasurys [sic] in December, while Japan was a net buyer, moving into top spot.”

But not to worry, according to Rosalind Mathieson, writing for the Wall Street Journal, this does not signal an imminent run by China on the dollar…

“For one thing, it would be counterproductive for a country which still holds so much in dollar assets (estimated at 70% of its total reserves).  And the euro is hardly an appealing alternative right now.”

Maybe so.  Nonetheless, the world is a wild and wacky place.  And often times people – and entire nations – do counterproductive things.  So, too, sometimes the unexpected happens…and quite frequently, if you can believe it, the impossible happens as well.

Curing Patients with Daffy’s Elixir

The economy, you see, is much less a scientific phenomenon than economists would have you believe.  Listening to Ben Bernanke or Paul Krugman speak you get the idea an economy is something that can be fine tuned and adjusted like the mechanics of a chemical processing plant.  If you turn the knobs just right and calibrate the filter presses for maximum slurry separation, you can enhance the operation for optimal output.

The economy, on the other hand, is a social phenomenon that is open-ended, constantly changing, and hardly predictable.  Correlations are nonlinear and outcomes are almost always misunderstood.  A Federal Reserve chairman rarely gets what they expect.

For example, the Fed lowered interest rates in 2001 to bailout stock market investors and unexpectedly set off a consumption binge.  Before the Fed knew why or how, production capacity bubbled up in China like a California hot springs.  Where was the demand coming from and why were all the manufacturing jobs leaving America?

Of course, a central banker would never cop to the fact that their funny money was sending false signals to manufacturers on the other side of the planet.  Instead, the most idiotic conclusions were drawn.  In 2005, Bernanke declared low interest rates were the result of a “global savings glut.”  And not long after a three time Pulitzer Prize winning writer penned an international best seller detailing how the hollowing out of American industry was just the consequence of “globalization” because, after all, “the world is flat.”

Here’s the point…

The Federal Reserve can tinker and toy with things but they may not get the results they expect.  They can entice people to go further into debt with super low interest rates, yet they can’t control where the money goes.  They can create money from thin air and loan it to the government, but they can’t control when or how much of these shenanigans will finally destroy the dollar.

When it comes down to it they know no more what they’re doing than an 18th Century quacksalver curing patients with Daffy’s Elixir.

Sincerely,

M.N. Gordon
Great Depression Online

P.S.  You can trust Bernanke knows what he’s doing.  You can switch on the news and hope for the real story.  You can read the papers and pray they know what’s actually going on.  Or this time, you can settle in, read his letter, and finally Get the Truth.

 

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