Money Policy and the Fed

Is it just me or do you get the feeling that the feds rewrite their money policy almost on a daily basis? It seems reactionary at times, but it’s the reaction caused by a previous policy blunder that creates a different reaction and a different blunder to follow….it’s a vicious circle!

So what do the feds actually want? It appears now that they want INFLATION! What? I thought inflation was bad. Well it is if it takes off at ground level, but the economist say we are now experiencing deflation, so the feds need inflation to compensate.

Maybe a short economics discussion is in order. Let’s look at the variables in very basic terms.

M=money supply – how much money is available

V=Velocity of money – how fast money moves through the system

P=Price of money – either inflation or deflation

Q=Quantity of Production – GDP

If you reduce V velocity (which is happening today) and if you don’t increase the M supply of money, you are going to have deflation. We are watching the velocity of money slow. People are getting nervous, they are not borrowing and spending as much, either because they can’t or for obvious reasons are using discretionary income to pay off debt or increase their savings. You would think this is a good thing for the family, reduce debt and save more, but not if you’re the government. This entire economy has been based on credit, borrowing, and spending…..velocity….which increases GDP, but this growth has been fictitious because we weren’t spending our money, we were spending our future earnings through debt. You knew it was just a matter of time before we would “max-out” our borrowing power.

The probability of deflation is ever increasing. When we increase M the supply of money and V, velocity stays the same, and if GDP does not grow, that means we’ll have inflation. More money chasing fewer goods…..it’s the old supply and demand equation.

As I said earlier we currently have slower velocity of money and thus slower growth of GDP. Keep this in mind: earnings equal growth. Without spending companies have little to no earnings which results in slower or stagnant growth or what we are experiencing now…..deflation. This scares the FED, so what is there answer? They have to keep printing money M until V velocity kicks in and we begin to see inflation. The feds are calling it “quantitative easing.” They announced $300 billion of easing last week. This will happen every quarter, $300 billion, $500 billion etc….until their achieve their desired result…..inflation. This could become a really big number and a side effect may be another asset bubble in the stock market. One economist said it may take $2 trillion of “easing” to achieve the desired result. However, will this cause the pendulum to swing in the opposite direction and double digit inflation will rear its ugly head? There has to be such a supply of cheap money to encourage lenders to lend and borrowers to borrow to induce a spending to produce inflation. This could take years to accomplish……and I don’t think we’ve hit bottom yet. Bill Fleckenstein is a very famous short trader. He closed a short fund a couple of months ago. He says he doesn’t have as many good opportunities, and basically he’s scared of being short with so much stimulus going on.

Another unintended consequence of printing so much money will be a weaker dollar…..this is an entirely different discussion but can we afford to have a weaker dollar globally? Who will buy our debt?

The real answer is staring us in the face, but we seem to overlook it. We have to get the FED’s out of the equation. Let the markets dictate interest rates, velocity, price, and growth. We can’t keep manipulating the country’s economy. It doesn’t work, hasn’t worked and will not work long term. This stimulus “fix” will probably end up being more of a disaster and make for a harder landing then would have otherwise been by letting the markets run their course. We will experience deflation followed by inflation followed by more manipulation so put on your neck brace because this economy is going to make your head spin!