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The Fed's Economic 'Growth Buying' Scheme Is Failing

Economics / Quantitative Easing May 13, 2014 - 11:51 AM GMT

By: Money_Morning


Shah Gilani writes: The numbers are in. And they are ugly...

Based on preliminary first-quarter data, U.S. GDP (gross domestic product) growth is 0.1%.

That's not much.

But then again what do you expect for $3.4 trillion dollars of Federal Reserve spending to boost the economy?

So the question is, how is it possible that we've got nonexistent economic growth, or worse, negative growth and possibly another recession looming, when the Federal Reserve since September 2008 has spent $3.4 trillion to prime the economic pump?

This could push the whole economy past the brink...

The Ugly Truth on Fed Intervention

First of all, the preliminary GDP number, which is the total output of goods and services produced by labor and property minus imports, will be revised on May 29, 2014.

A majority of economists are already revising their estimates down into negative territory.

The consensus view expects the revised or "second" GDP number will actually show the economy contracted by 0.5% to 1% in the first quarter.

Not that the second quarter is expected to be bad just because of a slow first quarter. In fact, a majority of pundits, including the Federal Reserve itself, are saying because the first quarter was so bad the economy will bounce robustly in the second quarter.

But if they're wrong and the second quarter shows negative growth, that's really bad.

It's bad because two consecutive quarters in a row of negative GDP growth is the definition of a recession.

Why has the Fed intervention failed so miserably in spurring growth? It's an ugly truth but needs to be told.

Since the credit crisis, which spawned the Great Recession, the Federal Reserve has been trying to build a bridge to growth. The truth is they've spent trillions on their bridge efforts, but they can't deliver the destination.

Here's what's frightening: What seems like misguided Federal Reserve policies to stimulate economic growth by printing egregious amounts of money was never a misguided policy of trying to stimulate the economy. It was a massive liquidity and profit-making program designed to first save, then enrich, the nation's biggest banks.

Economic growth was the expected byproduct of the Fed's "trickle-down" banking bonanza.

Why It Didn't Work

The reason we're not seeing that trickle-down growth is because the banks aren't lending as they were expected to.

They aren't lending robustly into the economy because they've had to pay out billions of dollars in fines and legal costs.

That plus their former freewheeling speculative trading gambits with depositor money are being shut down thanks to Dodd-Frank and the Volcker rule, and they are facing their worst free-market enemy, a flattening yield curve.

It's common knowledge that all the nation's too-big-to-fail banks would have all failed if the Fed hadn't bailed them out. Any one of them collapsing, after what happened when Lehman Brothers imploded, would have brought down all of them like a professional bowler throwing a 50-pound ball down an alley with gutter guards.

It's impossible for there to be any economic activity if there are no banks. So, the Fed did what it had to do to save the big banks.

It flushed them with trillions of dollars.

To get their footing back, the Fed took bad loans off their books and opened up its discount window to all comers for all they needed.

They also took in underwater mortgage-backed securities (MBS) and bad loans as collateral for the cash they lent them. To ensure their return to massive profitability, the Fed then embarked on quantitative easing, or QE.

QE is another giveaway program for the big banks. The Fed buys tens of billions of dollars a month in treasuries and MBS from the banks.

The banks in turn get cash, and they lend overnight at the fed funds rate. The Fed set the fed funds rate to essentially zero, and with their borrowed cash the big banks buy more treasuries and MBS to sell next month to the Fed.

It's a great way to make risk-free money and for the big banks to improve their capital ratios and reserves and profits. All of which makes them flush enough to raise dividends, which makes their equity stock look better to investors. And the icing on the cake is that they get to raise dividends to entice more investors. It's a great game.

Too bad the banks are the only ones benefiting directly. The whole trickle-down thing isn't working.

What Has the Big Banks Terrified

Besides hoarding money to pay ongoing and future fines for criminal activities, all the big banks are terrified of the shape of the yield curve.

The yield curve is a graphical representation of interest rates. On the vertical left axis are interest rates rising from zero to whatever height they attain. The horizontal axis is time, with one day all the way on the left and going out to 30 years on the right end of the axis.

Banks borrow from each other, usually for a day at a time, at the fed funds rate, which is a market rate but a rate that the Fed largely controls. The fed funds rate is somewhere between zero and .025% now, as that's where the Fed manipulated it to. As the line that traces interest rates moves to the right, it trends higher. That's because you pay a higher interest rate to borrow money you intend to pay back over a longer time.

Normally the yield curve slopes upward steadily, so that interest rates to borrow for a day might be .25% (on an annualized basis) and 5% or 6% or more for a 30-year mortgage.

But the yield curve is flattening, not steepening, for a few reasons.

Investors are buying 10-year and 15-year and 30-year bonds because their yield is better than what they would be paid if they bought shorter maturity bonds.

One reason that longer-term interest rates aren't as high as they are expected to be is because rates are so artificially low (courtesy of the Fed' manipulation) that investors are going further out on the "risk spectrum," meaning they're willing to lend out money for longer to get more yield.

But another reason there's so much interest in longer-dated bonds is that investors are seeking a safe place to park their cash in anticipation of falling yields because of a market crash or some global macro-event that panics markets.

In other words, investors are fearful.

One of the reasons is that they don't believe the Fed's low interest rate policies are creating growth and that the economy could fall back into recession, which would cause yields to fall even further.

So they want to lock in whatever higher yields they can get now.

The flattening of the yield curve is bad for banks.

When they lend out for a long period of time, they want to charge as much interest as they can.

But if the yield curve is flat and investors are willing to take less interest, they can't charge as much interest as they would like.

If you're a bank and you make loans, you price them according to your risk of being paid back and how long you're making the loan for.

Banks don't want to make long-term loans and not get paid; that's too much risk. That's why they're not making loans hand over fist, even though they have the money to lend.

Thanks to the Fed's QE, banks are better off doing business with each other and the Fed than the public. If there's no credit, there's no economic growth.

And that's the dilemma we're facing.

And most frightening of all, the consequences of no growth and the Fed's money printing are about to devastate equities (again), some bond investments, commodities, real estate (again), and other asset classes.

Don't wait for the Fed to scuttle the economy. Shah helped create a powerful index that you can use to make money no matter what happens. You'll need this when the crash comes... Get the Report

Source :

Money Morning/The Money Map Report

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