Current Economy puts the Fed in a Lose-Lose Situation

Earlier in the week we heard from our good friends at the Federal Reserve, regarding the economy and potential action by the Fed. To the disgust of many, the Fed decided to sit back and do… nothing? That’s right, Fed. Chairman Ben Bernanke and friends are staying on the sidelines for the meantime, monitoring the US economy, and keeping an eye on the saga in Europe (while probably placing a few wagers on how much worse Greece can make its’ situation). Regardless of the decision though, the Fed will remain under severe scrutiny, and many blame them for much of our current problem (some deserving, others not). Allow me to explain….

Many people ask how they could just sit back and do nothing? It is quite simple really; the Fed is basically out of bullets. We have seen a couple rounds of Quantitative Easing (QE), and newly started project of “Operation Twist”. These programs are designed to supply a struggling economy with cheap money, with the intent of encouraging firms to use in funding their business and stimulate growth. A great idea in theory, a little more difficult in practice. What many don’t see is the manipulation in yield curves, bond prices and fixed income prices. What has happened, firms have taken this money, and done…nothing. We see financing institutions and some other companies sitting on record amounts of cash, rather than spending. Why? Well, with Europe a mess, the US economy stagnant, why would you spend? If chaos occurs in Europe, we could see borrowing rates jump, and without growth, that will slow things down even more. It makes sense to borrow and hold now then to borrow later at higher costs. If things go bust domestically like 2008 again, firms know they will need as much liquid capital on hand as possible. New regulations enacted by Congress also played a hand in this as well. Congress requires certain industries and businesses to have a predetermined amount of cash or capital on hand at all times. By restricting cash flow, funds available for business operations now have to sit in the bank, or in some executive’s office.

In addition to QE and other programs, the Fed has lowered interest rates to historic levels. However, low interest rates destroy those who save or rely on interest to make profits. So why cut interest rates then? This idea is the same as the last one, cheap money in the market.

Consumers are also fired up at the Fed with respect to currency rates and the value of the dollar. Currently, we see our dollar at lows we are not accustomed to. This however, is a trade off of low interest rates, cheap money in the market, and excessive spending. The next logical question is to ask is, if firms aren’t going to spend, why lend them money? Well, how bad would things be without any lending? Firms would be undercapitalized, demand would be even lower, and you can run the risk of the market for a certain good freezing as a whole.

So where does this leave us? Should we bump up interest rates to be back at normal functioning levels? Well, that may increase the value of the dollar, but doing that with economic recovery only prevents us from growing. Do we keep it low, leave the dollar depreciated and try to encourage lending and business? How do foreign markets influence this? Or do we sit back and see how things sort themselves out in the short-term, then act accordingly? That is exactly what the Fed is doing, and this time, they got it right. Regardless of the action taken, criticism will fly in from all sides, whether it is in their control or not. It is safe to say that I wouldn’t trade jobs right now; I’m not sure about you. While the Fed is in charge of our monetary policy, monetary policy isn’t direct driver for job creation. As long as politicians use the Fed as their scapegoat and punching bag for poor fiscal policy and their manipulation, much of what we see is what we’re going to get.