The Fed’s Self-Defeating Policies: Any Method Behind The Madness?

There’s always a list of things that answer the age-old question of “When?” You know you’re old when… or you know you’re a Yankee when… or (you knew it was coming) you know you’re a redneck when, etc.

Let’s add another list based on finance.

You know the world’s gone crazy when the government tries to force-feed inflation, consumers are encouraged to borrow, saving is frowned upon, and markets cheer bad news because it means the Fed is likely to hold interest rates negative for longer. It’s completely backwards!

As individuals we should save more, take on less debt, strive for low or even no inflation, and push for the Fed to stop meddling in the markets. Achieving these things would make each of us more financially secure and would preserve the spending power of the funds we’re able to save.

But while politicians and agency heads pay lip service to teaching Americans to provide for their own future, these same people spend their days desperately trying to engineer a return to the economy of 2004, when we spent everything, saved almost nothing, took on record amounts of debt, and paid little attention to the costs of the falling dollar. It’s a classic case of chasing short-term gain at the expense of long-term pain.

In this case, what’s good for the goose isn’t necessarily good for the gander.  One man’s spending is, after all, another man’s income, so a lack of spending by some leads to lower income for others, including less employment in general.

Refusing to take on debt is the same thing as saving in a way, and has the same effect on the economy assuming that we take on debt in order to purchase things.

As for inflation, it helps borrowers by making debt payments more affordable because the debts are repaid with less valuable dollars.  This is important since, even after their efforts to reduce their debt outstanding, Americans personally still owe trillions, and the federal government owes about a full year’s GDP at roughly $18 trillion.

Low interest rates also help borrowers. Anyone with a savings account, money market account, or CD knows that rates are near zero even though core inflation, while low, is running over 1.5%.  This allows borrowers to take on debt that is nearly free of interest, since their cost of borrowing will be barely above the rate of inflation.  The biggest beneficiary of this is the U.S. government because it has the largest amount of debt outstanding.

Unfortunately, higher inflation and low interest rates hurt savers.

Just as one man’s spending is another man’s income, one man’s savings is another man’s loan. Holding down the cost of such loans provides an unfair advantage to the borrower at the expense of the saver, who is denied his market rate of interest. Pushing up inflation will assist the borrower, but erodes the value of the payments received by the lender.

All of this is done in the name of reinvigorating the economy, even though it causes massive dislocations in the markets.

The problem is competing motivations. The government wants to see savers spend more, while the savers themselves have a different goal — accumulating enough wealth to carry them through retirement years.

The irony is that government and Fed policies are eventually self-defeating, because they discourage savers from spending even less than they already were. As long as interest rates remain low, savers must sock away even more cash in order to meet their investment goals.”

Which brings us to the real demon that Fed governors and politicians are fighting. It isn’t a mindset on the part of consumers and savers. It’s the way demographic waves are washing through our economy.

The bulk of the boomers, the largest generation in our population, were born in the late 1950s and early 1960s. As this group moves through their peak saving years, from 50- to 65-years old, they are focused on paying down debt and putting away more resources for retirement — NOT spending more.

At the same time, the generation following them, Generation X, is much smaller and doesn’t have anywhere near the same spending power as the boomers.  They can’t fill the consumption vacuum that the boomers left behind.

Short of guaranteeing everyone’s financial future so that they freely spend all of their assets today as well as borrow with abandon, there’s little the Fed, politicians, or anyone can do to change the way these forces work in our economy.

Circling back to the top: You know the world’s gone crazy when policy makers ask us to commit financial suicide, and are stunned when we refuse.

Image RJ sig
Rodney

P.S. So if the Fed can’t do anything about the way our economy is running, what exactly are they doing? Lance explores this question in today’s Ahead of the Curve. Keep reading

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Categories: Economy

About Author

Rodney Johnson works closely with Harry Dent to study how people spend their money as they go through predictable stages of life, how that spending drives our economy and how you can use this information to invest successfully in any market. Rodney began his career in financial services on Wall Street in the 1980s with Thomson McKinnon and then Prudential Securities. He started working on projects with Harry in the mid-1990s. He’s a regular guest on several radio programs such as America’s Wealth Management, Savvy Investor Radio, and has been featured on CNBC, Fox News and Fox Business’s “America’s Nightly Scorecard, where he discusses economic trends ranging from the price of oil to the direction of the U.S. economy. He holds degrees from Georgetown University and Southern Methodist University.