Has the Fed Outlived Its Usefulness ?

by: Bruce Pile

The recovery from the recession is showing some bright spots such as retail activity and corporate earnings. The big bug-a-boo still is employment. It continues to carve out a record weak post-recession return to normal.

What's the problem ? With our high-powered Fed, now more high-powered than ever, you would think we could snuff out a nagging problem like this. But maybe that's just the problem. Our Fed has been busy snuffing out problems for so long that it has created a problem that can't be snuffed out - the mountain of debt left over from all the snuffing.

click on charts to enlarge

If you compare the two charts above, you can see the sharply growing employment lag back to normal in each recession recovery from 1980 onward in chronological order correlating with the sharply growing debt level. Hmmm - I wonder if there could be a relationship here.

We hear a lot about all the Fed's largess going to repair the mortgage ravaged balance sheets of banks, making them hesitant to lend. But the mortgage ravaging was the left-over of the Fed's previous snuffing project. I guess these lenders' repair of the balance sheets gets to be a bigger job each time.

I can't quote the Fed's original charter (something about protecting the currency) but their operating principle seems to have been fixing everything from systemic collapse to a hang nail with a generous dose of debt. Thank God we've had the Fed to protect our currency. Whatever they do seems to create and/or subsidize debt at all levels.

For all the trouble the Fed's debt creation causes, we are getting less and less bang for the debt dollar as the decades roll by:


This chart shows the diminishing positive effect of each debt dollar on GDP growth since 1954. Nouriel Roubini likes to show this and project "zero hour" - when piling on new debt gets us nowhere. A straight line fit through the data hits zero at 2015. A curve fit (red line) gets there even sooner.

This out-of-control debt dynamic is nothing new here in modern America. A fascinating article over at zerohedge.com points out the math of debt creation vs the math of economic growth (very simple math) and how previous civilizations have dealt with it. When you think about, the effects of debt, even if its base doesn't increase, grows at the rate of interest and balloons to monstrous levels over 100 years due to the magic of compounding alone. It reminds me of the 100 year old bond purchased by an eviction case for Andy and found in his belongings after he was kicked out of his house in the old Andy Griffith episode. It was purchased for only $100, but Mayberry couldn't afford to pay him the $264 grand it now owed him. The world economy is going to have to find some kind of currency loophole, like the confederate money the Mayberry bond was issued in, to resolve this issue, or have some kind of jubilee declared as in past centuries.

Last November's election was, at its core, a debt revolution. The Tea Party this time is a revolt, not against England's meddling with our colonies, but against another foreign entity meddling with our freedoms - the federal government in general and the Federal Reserve System in particular. I always used to think Jim Rogers' call for abolishing the Fed to be a little extreme. Now I see a poll out just last week with the stunning title "More Than Half Of Americans Want The Fed Reined In Or Abolished". Many are wondering how much of the good economic numbers is Fed-snuffing. They look at employment as being the one thing perhaps not so easily juiced by the Fed.

We needed the bailing of too-big-to fail entities in 2008. But runaway corporate 'government' with no federal regulation was why we needed this extreme action in the first place. All they did was encourage the mortgage bubble and abolish the Glass-Steagall safeguard that emerged from the last fiasco of the 1930s. One thing is certain, debt and the Fed both are not viewed the same way anymore. Most Americans don't want too-big-to-fail anymore and they don't want too-big-to-bail either. After we strayed from silver and gold being our money for centuries about a hundred years ago, the Federal Reserve System was put into action in 1913. Now 100 years later, we find the Fed model has run into the ditch, and we may not be too excited about pulling it back onto the road.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I am long debt sensitive holdings in general such as gold.