Monday, December 23, 2013

Happy 100th Birthday to the Federal Reserve!

The central bank of the United States is one hundred years old today.  I'll bet the Board of Governors is having a blast celebrating the Federal Reserve's long history of achievement.  Let's review the Fed's more notable achievements.

Here's a CPI chart showing how the Fed has degraded consumers' purchasing power since World War II by managing inflation.  The Fed kept inflation artificially high after the war to make it easier for the US government to repay its war debt.  Patriotic Americans who bought war bonds got ripped off in later years as inflation eroded the purchasing power of the bonds' principal at maturity.  Oh BTW, the Fed learned this inflation war-funding trick in World War I according to the Mises Institute.

Here's what the NBER had to say about the Fed's ability to control inflation during World War II.  Economic legends Milton Friedman and Anna Jacobsen Schwaartz saw the Fed's expanded balance sheet as a plus, if only the Fed had sold securities to control inflation.  The implications for Fed's huge balance sheet today are obvious.  If the Fed begins to reduce its balance sheet by selling the agency paper it has acquired through QE, the deflationary effects on our economy will destroy the stock and bond markets.  The Fed must really like inflation.  Remember that the next time you buy groceries or pay your energy bill.

The Fed's greatest hits aren't all in ancient history.  The hits keep on coming today.  Bloomberg's US bond data shows us what the Fed's ZIRP is doing to the short end of the yield curve.  Rates from three months to two years are at zero, so investors using bond ladders are forced to seek yield buying much longer termed bonds as their shorter maturities expire.  Those long bonds are much more sensitive to interest rate changes than short term bonds.  Rates at the long end have risen this year.  Prices have an inverse relationship to rates.  Fixed-income investors can thank the Fed for any unhappy birthdays to come as their bonds decline in value.

Hey, I just thought of something.  The Fed's periodic audits have not shown us physical proof of the system's gold reserves.  Who's watching that bullion?  I have an idea.  Here's an exclusive look inside the NYFRB's bullion vault courtesy of Alfidi Capital.

LOL, just kidding.  I've never been inside the Fed's vaults.  I think cats running the show would be an improvement over the current state of affairs.  Someone has to provide continuity while Helicopter Ben hands the baton to Calamity Jane.  They could always pick me for a vacant Fed BOG seat, as I have more qualifications than a LOLcat.

Central banks were once a great idea.  I'm not clear how they add value today.  They're supposed to stabilize our financial system but prolonged interventions give rise to instability.  Artificially suppressing interest rates leads to distortions in the cost of capital that investment managers and corporate project managers use to plan investments.  This places economic growth at risk.  Playing games with interest rates means foreign central banks can't trust the value of their dollar-denominated securities.  This places the dollar's world reserve status at risk.  The Fed had a role to play the United States' growth as a world power.  Its indefinite monetary stimulus is now risking our world power status.  Happy birthday, indeed.