Tuesday, October 07, 2008

ZIRP: Our Future

Well folks, approval of the massive bailout plan wasn't enough to calm global markets, so it looks like the Fed will cut rates again - soon!

Based on Bernankes gloomy speech and the cratering of global markets today, the Chicago Board of Trade, futures market is indicating a 48% chance that the Fed will lower its Fed Funds Rate (FFR) to 1.5% from today's 2%; additionally the futures showed a greater chance (58%) that the rate will be cut 3/4% to 1.25%.

Note: This will likely be a nice positive for Gold, a negative for the US Dollar and highly inflationary for consumer wallets.

Anyway, if you can recall back to April of this year - when the market movers (due to rising inflation pressures, a slowdown in unemployment figures, a rising equity market and a less volatile credit market) were all talking in unison about a rate pause and likely future rate increases. I raised the BS Flag Immediately!

My Quote:

" I don't buy it, as there are still far too many uncertainties out there for the Fed. I expect a 25Bp cut this time around followed by another in June (or an emergency cut if warranted beforehand) and a 1.25% rate by the end of the year."

" We are nowhere near the end of this housing/credit/insolvency crisis and think ZIRP (Zero Interest Rate Policy) is not out of the question in our future. Each time a new crisis erupts, the fed will print/cut/inject in an effort to contain it, but will eventually run out of monetary ammunition... That's when the real hyperinflationary fireworks will begin."

Speaking of ZIRP:

Back in a November 2007 post Will the Fed Cut Rates again on December 11? I made fun of Paulson's "Strong Dollar Policy" and then got to the crux of the matter: The Fed and PPT would use EVERY tool/instrument at their disposal to fight off the deflationary impacts of the credit crisis and the banking/financial system implosions

My Quote:

" Ultimately, reduced credit leads to reduced money creation, which leads to reduced spending which leads to a deflationary environment - But have no fear, Ben and the Boyz are here."

Based on the comments Ben Bernanke made in his 2002 speech before the National Economists Club in Washington, D.C., Helicopter Ben made it clear the Fed would do everything in its powers to prevent deflation: Deflation: Making Sure "It" Doesn't Happen Here

So, what are the tools Ben feels the Fed should use to prevent deflation?

The Fed could cut rates to ZERO, while simultaneously they could print/inject massive amounts of fiat money into the system. See excerpts from the link below (Note: Emphasis is mine)

“ But suppose that, despite all precautions, deflation were to take hold in the U.S. economy and, moreover, that the Fed's policy instrument - the federal funds rate - were to fall to zero. What then? In the remainder of my talk I will discuss some possible options for stopping a deflation once it has gotten under way."

" Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation."

There you go, he said it - print more money to reduce its value and to generate more spending (sounds like a call for Hyperinflation)

“ Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior). Normally, money is injected into the economy through asset purchases by the Federal Reserve. To stimulate aggregate spending when short-term interest rates have reached zero, the Fed must expand the scale of its asset purchases or, possibly, expand the menu of assets that it buys. "

"Alternatively, the Fed could find other ways of injecting money into the system--for example, by making low-interest-rate loans to banks or cooperating with the fiscal authorities. Each method of adding money to the economy has advantages and drawbacks, both technical and economic. One important concern in practice is that calibrating the economic effects of nonstandard means of injecting money may be difficult, given our relative lack of experience with such policies. Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.”

"Unlike some central banks, and barring changes to current law, the Fed is relatively restricted in its ability to buy private securities directly. However, the Fed does have broad powers to lend to the private sector indirectly via banks, through the discount window".

"Therefore a second policy option, complementary to operating in the markets for Treasury and agency debt, would be for the Fed to offer fixed-term loans to banks at low or zero interest, with a wide range of private assets (including, among others, corporate bonds, commercial paper, bank loans, and mortgages) deemed eligible as collateral. For example, the Fed might make 90-day or 180-day zero-interest loans to banks, taking corporate commercial paper of the same maturity as collateral. Pursued aggressively, such a program could significantly reduce liquidity and term premiums on the assets used as collateral. Reductions in these premiums would lower the cost of capital both to banks and the nonbank private sector, over and above the beneficial effect already conferred by lower interest rates on government securities."


Thus far, though out of order and minus ZIRP, Ben and the Boyz have used every single tool mentioned/outlined in that 2002 speech.

With another rate cut in the works and with financial system troubles mounting, my April 2008 call for a 1.25% FFR by end of year will likely come to fruition.

What then should we expect to see?

Well folks, when stuck with a measly 1.25% FFR going into next year, the fed will have very little ammunition left in his "bag-o-tricks" with which to fight the worsening battle, so ZIRP will be implemented in 2009 followed by a massive monetization program.

Bottom Line:

Massive Monetary Inflation (ZIRP + Monetization) coupled with Severe Asset Deflation (Credit Crisis + Collapsing asset values) and high unemployment = A HYPERINFLATIONARY DEPRESSION

Hope this is an easy enough concept for everyone to follow



Virgo said...

Karl Denninger says that today 10.7. 2008 there was a sell off of both stocks AND bonds. Not good. He's telling people to prepare for stock/bond/credit collapse and have enough cash and food for at least 6 months.


Randy said...

Holy Crap!

Thanks Virgo. Tried watching it but the video keeps freezing up - imagine its getting quite a few hits and clogging the server.

Will watch it later


Anonymous said...

What preparations might you suggest to help survive the turmoil to come? Survivalism and living in an urban area seem like polar opposites. I assume the basics ... some amount of stored food, water, fuel, paper money (or even better, gold), medicines, security (guns and ammo), communications gear. What else do you think is essential?


Excessive money creation will solve nothing. It will only help push asset prices higher.


Great news and info.