2012 January 25 | timiacono.com

Fed to Keep Rates Freakishly Low Thru 2014

It looks like I underestimated the Federal Reserve’s largess in the New Year when I extended their freakishly low interest rate guarantee by only a year in the chart from this earlier post.

Turns out, in their policy statement today, the central bank added a full year-and-a-half to their low-rate pledge, more bad news for conservative savers who were hoping for a little better return on their money after three years of punishment, but great news for owners of precious metals that soared today on the news.

It’s not hard to understand why gold and silver prices shot upwards.

Low or negative real (inflation adjusted) interest rates are about the single best predictor of rising metal prices and it’s pretty hard to get a positive inflation adjusted interest rate when you start out with an interest rate of zero.

Pimco’s Bill Gross seems to think that this amounts to “financial repression”, a term that we’ll be hearing lots more between now and 2014. Today’s action was seen as, effectively, QE2.5, with the groundwork now laid for QE3, QE4, etc.

It looks like Richmond Fed President Jeffrey Lacker will be 2012’s lone dissenter as he voted against today’s action, preferring not to state a timeframe for how long rates are expected to be kept freakishly low.

The Fed also lowered their expectations for real U.S. economic growth, from a range of 2.5 to 2.9 percent to just 2.2 to 2.7 percent, and said they expect the jobless rate to end the year at between 8.2 to 8.5 percent, a slight improvement from their prior forecast.

Oh yeah. The central bank now has an inflation target too – 2 percent. Just don’t pay any attention to food prices that are rising by multiples of that amount because the Fed knows what it’s doing here. It’s all good (i.e., if you own precious metals).

What Happened at the FOMC Meeting?

I’m not around at the moment to comment on the results of today’s FOMC (Federal Open Market Committee) meeting that concluded a few minutes ago, likely to have resulted in some sort of announcement about the central bank’s communication policy and an enhanced economic/policy forecast, but, when I’m able to catch up on this and Fed Chief Ben Bernanke’s press conference, I’ll try to put something up later in the day.

Based on what I’ve been reading about an extension of the Fed’s freakishly low interest rate guarantee, we’re probably looking at the situation to right.

This is not going to make savers happy, but, if you like to borrow money, you’re likely to get lower rates for a while longer.

Come to think of it, those low-rate credit card offers could be arriving in our mailboxes for the rest of the decade.

Anyway, I’m hoping that someone asks Bernanke about the 2006 FOMC meeting transcripts and how the nation’s brightest economists could have been guffawing all year long when they maybe should have been looking at the rapidly inflating housing bubble that would burst a year or two later.

See The Fed’s Housing Bubble Laughter from the other day for the particulars about this.

How to Save Economics?

Following yesterday’s generally well received diatribe about the shortcomings of  the world’s economists, this Time Magazine commentary was stumbled upon that makes some of the same points, absent what I thought were important references to The Shining.

After the financial crisis of 2008, the Queen of England asked economists, “Why did no one see the credit crunch coming?” Three years later, a group of Harvard under­graduate students walked out of introductory economics and wrote, “Today, we are walking out of your class, ­Economics 101, in order to express our discontent with the bias inherent in this introductory economics course. We are deeply concerned about the way that this bias affects students, the University, and our greater society.”

What has happened? Rebellion from both above and below suggests that economists, who were recently at the core of power and social leadership in our society, are no longer trusted. Not long ago, the principal theories of economics appeared to be the secular religion of society. Today, economics is a discipline in disrepute.

First, economists should resist overstating what they actually know.

Second, economists have to recognize the shortcomings of high-powered mathematical models, which are not substitutes for vigilant observation. Nobel laureate Kenneth Arrow saw this danger years ago when he exclaimed, “The math takes on a life of its own because the mathematics pushed toward a tendency to prove theories of mathematical, rather than scientific, interest.”

Financial-market models, for instance, tend to be constructed with building blocks that assume stable and anchored expectations. But the long history of financial crises over the past 200 years belies that notion.

And that is why few economists saw the financial crisis coming – because they had their noses buried in models that failed to properly reflect what was happening in the real world.

I’ll never forget former Fed Chief Alan Greenspan’s remarks before Congress in 2004 or 2005 when he said there was virtually no stress in the banking system when, at the time, the real action was in the now-defunct  “shadow banking” system.

Apparently, Fed economists didn’t see the need to model that.

India, Iran, Oil, and Gold

The Iran oil embargo and freeze of its central bank assets approved by Europe the other day has had an interesting unintended consequence – and not just another threat by Iran to block the Strait of Hormuz. According to this Debka report, India has agreed to pay for Iranian oil with gold instead of U.S. dollars and China is expected to follow suit.

So far, there has been no official confirmation of this story and, at the moment, I’d have to agree with this commentary at Commodity Online that it’s probably best viewed as a rumor, but, if both India and China do intend to pay for their $25 billion per year in oil purchases from Iran with the yellow metal, that could result in a lot of gold being mobilized.

Of course that wouldn’t necessarily mean that the gold price will rise. India could simply exchange their currency for gold, transfer ownership of the gold to Iran in exchange for oil, and then Iran could exchange that gold for whatever currency they desire, having no net effect on gold demand. But, it certainly won’t hurt the gold price and will surely further diminish the reserve currency status of the U.S. dollar.

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