By: Dr. Jeffrey Lewis
Inflationary practices are the primary driver of growth in the value of precious metals, and they are already in play to combat the credit crunch. Although the Federal Reserve is planning its exit strategy, there is little chance one will actually be enacted – which means that inflation will continue to bulldoze the value of the US dollar.
#1 Reason: All Stops Have Been Pulled
Never before in the history of the Federal Reserve have rates been allowed to plummet as low as they have today to combat the most recent financial crisis. Today's rate of 0-.25% is the lowest the Federal Reserve can issue without literally paying banks and lenders to borrow money.
Since 1983, Federal Reserve rates have fallen from 9% to 7% in 1987, 3% in 1992, and 1% in 2002 to today's nonexistent 0 – .25% rate. The Federal Reserve has nothing left in its interest rate arsenal to combat the crisis. With the Fed’s fuel is running on low, a further reduction in rates is all but impossible. If the Fed loans at a negative rate, they'll be losing money with each loan made!
#2 Reason: Low Rates Help Banks
The financial crisis was largely started by banks that did not have enough capital to shelter themselves from any decline in the economy. Subsequently, the Fed reduced its rates to help revive the failing financial industry.
The Fed’s low interest rates have benefited the banks not only through better spreads on consumer loans, but also better returns on Treasury purchases. For instance, banks can borrow from the Federal Reserve through the window at 0 – .25%, and then lend to the US government via Treasuries and earn a hefty 1.4% in one year Treasuries. The arbitrage allows for essentially no risk and no collateral, but dramatic profits for any institution with access to the Federal Reserve's lending window – all at the cost of everyone else.
Low rates also help keep governmental borrowing expenses lower, which is important considering the $1 trillion deficit Congress has deployed to “stimulate” the economy.
#3 Reason: An Exit Would Temporarily Disable the Economy
Prior to the creation of the central bank, bank runs were devastating, even though they lasted only a period of months. Modern recessions last for years and ultimately harm more people, as the unemployed remain fully out of the workforce until any recovery.
Although a Federal Reserve exit would help the economy in the long term, the short term fluctuations would seem catastrophic to anyone not already familiar with the history of monetary policy. If the Fed were to exit, the US government budget would have to be immediately balanced, and the US economy would have to wean itself off its credit addiction and into real capital.
The Bottom Line: Preparing Yourself
Chairman Ben Bernanke has made it evident that today's low rates will not be changing in the near future, regardless of any economic “green shoots.” As we cannot change monetary policy enacted by the Fed, the second best response is to buy precious metals, which will only head higher as more and more inflated dollars work their way into the system. Much of the vastly increased money supply remains in the coffers of the banks; however, when the Fed removes the ability for easy arbitrage between the Fed and the Treasury, the amount of dollars in circulation will explode.
Dr. Jeffrey Lewis