The Federal Open Market Committee (FOMC) released its statement today saying that it is likely to leave rates near zero until late 2014. If this ends up happening, that means that the overnight rate for borrowing will have been near zero for 6 years. The Fed dropped the rate below .25% after the economic fall of 2008.
As I have said before, the Federal Reserve is not really controlling this rate right now. This is the rate that banks are charged to borrow money overnight in order to meet reserve requirements. However, since the Fed has more than tripled the adjusted monetary base, the excess reserves held by commercial banks have skyrocketed with the monetary base. Since banks have huge excess reserves, they don’t need to borrow from the overnight window because they are not falling below the reserve requirements.
These low interest rates are not without a cost. Overall low interest rates hurt savers. This discourages saving, which is required for capital investment, which is required for future economic growth. People who are saving money in a bank account right now are losing in a major way. They are earning a fraction of a percent in interest. They are not even keeping up with inflation.
In Bernanke’s press conference this afternoon, he suggested that QE3 (more money creation) is possible if economic conditions warrant it. This should come as no surprise. He did not earn the nickname Helicopter Ben for nothing.
In the FOMC statement, it was also stated that the Fed would continue its program of extending the average maturity of its holdings. This means that it will be swapping shorter-term bonds for longer-term bonds. I suspect this is an attempt to keep mortgage rates down, along with borrowing costs for Congress.
As Gary North has said, the Fed is in Goldilocks mode right now: not too hot, not too cold. It does not want to tip the scales to recession or high price inflation. If and when the Fed faces a situation of high price inflation, it will be in major trouble.
The stock market, the bond market, and gold, all reacted positively to this news today. The dollar fell. This is not surprising. Stock market investors like to hear news of low interest rates and the possibility of more money creation.
Bernanke and his cohorts really don’t know what they are doing. They are playing politics and they are hurting the economy. There will be a day of reckoning. We can’t know when that day will be. There will be a day when the Fed has to make a big decision. It will have to stop creating money and let interest rates rise and severe recession hit, or it will keep creating money and go to hyperinflation. Let’s hope they choose the former and not that latter.