The Fed Quest For Neutrality

July 27, 2005

These modern alchemists at the US Federal Reserve are in a pickle. They must promote an image of seeking monetary neutrality in the setting of interest rates. The Greenspan Fed continues to raise short-term targeted rates, with clumsy calls for more "measured pace" hikes. The technical justification is more amusing, if not embarrassing. That is, embarrassing if they intend to pass themselves off as central bankers. They must pose as bankers and play the role. In my view these guys are mere inflation engineers and political representatives from the banking center. A system which has forfeited almost its entire manufacturing base, has outsourced an increasing amount of its services, and relies so heavily on asset inflation, equity extraction, zero-percent transaction finance, such a system cannot revert to normalcy with walking through fire for a prolonged period of time. The current path is pointed in the wrong direction. Instead, what we have is a recurring series of economic fantasies which an ill-trained public is eager to latch onto and an engrained investment community is eager to perpetuate. In the article "Economic Mythology" from almost a year ago, a premise was upheld that in the United States, a complex system has emerged with irrational beliefs which have no bearing on reality. Myths perpetuate because the monetary system cannot stand on its own merits. NOT EVEN CLOSE.

Since Greenspan took the helm almost 18 years ago, we have witnessed a pathogenesis toward the bizarre in monetary leadership which qualifies as incompetent and heretical, the near opposite path laid by Paul Volcker. Sadly, there is no way back. No path of bread crumbs can lead our system back to normalcy. Once upon a time, central banks actually were devoted to legitimate justification of policy, founded in valid economic practices, and not to a scummy outpouring of professionally adolescent excuses for their absurd indefensible policies. To defend the current system, the powers that be use their own printed money to purchase key securities like the 10-yr Treasury Note, like the S&P500 basket, like gold short futures contracts, and has even enlisted the Bank of Japan in collusion. The USFed has ventured so far afield from sane sound scrutinized principles, that its credibility has been undermined. Some say it has lost control over interest rates and the Treasury credit market, as control swings from US shores to ceded Asian shores. An argument can be made that the USFed has morphed into a gigantic monetary drug dealer enterprise. How does a crack cocaine addict turn a new leaf and reform? How does a man who goes through a bottle of Jack Daniels on a daily basis reform? How does a devoted methamphetamine crankhead go straight? It can be done, but it takes a couple years, deep courage, broad support, professional guidance, an excellent plan, and willingness to endure considerable pain. We have none of these.

Greenspan has led us down a dead-end path. Perhaps this is the ultimate destiny of democracy, where mere mortals are in charge of the national purse and monetary spigot. We are long past the nonsense of "Trickle Down" beliefs in the 1980 decade of supply side economics. It did not trickle down, but we still claim it did. We cling to faded memories of the nonsense in the 1990 decade for the "Technology Miracle" based upon productivity. Consumers, not businesses, saw the benefits in lower prices and a flatter playing field which yielded lower profits. Its miracle is still trumpeted by a clueless Greenspan, totally ignorant of technology, if truth be known. He does not even use email, could not download a file to save his shocks of wispy hair, and possesses no mouse skills. In the last couple years, we have been subjected to more heresy in the "New Economy" nonsense. International credit flexibility (more like welfare, confiscation, and dependence) combined with asset inflation (justified as wealth generation). The world monetary system has de-evolved into a Bretton Woods Plastic Accord, as the US "plastic" credit card economy relies upon unending surpluses from Asian benefactors. We have tragically become dependent on the generosity of strangers, even as we pursued their aggravation.

Any attempt to discuss and pursue sound economic policies based on time-tested survival, nowadays are met with mockery, laughter, and derision. The word "neutrality" has been bandied about in recent months as the USFed has reversed its measured ratcheted inflationary machinery and madcap lab-rat experimentation. What is neutrality to those people who stand on ground based in reality? An interest rate can be deemed neutral when it encourages a stable balance between supply and demand for money. What a novel thought!!! What does that mean though? Money is supplied from savings (not a printing press). Money is demanded by borrowers for productive usage (not speculation). A proper neutrality in interest rates is achieved when personal saving & business investing are in balance. Focus is on productive borrowing to create new businesses, to expand the labor force, to generate income. It is not borrowing to go on cool vacations, to purchase that cute lakeside cottage, to finance a room addition on the homestead (empty nest from long departed children), nor to get the resident teenager a car. A downstream measuring stick of proper neutrality is seen in actual monetary growth. It is achieved when the economy grows at the same rate as the money supply.

The United States has negative savings, near nil business investment, and money supply growing at 5 to 7 times the actual economic growth rate. In 1995, credit expansion was four times the available national savings, $1.13 billion versus $310B. By 2004, credit expanded by $2720 billion, almost 20 times as much as a pitiful savings rise of $130B. And that savings total permits inclusion of nonsensical $800 billion in homeowner self-paid rent. Yes, the US savings rate is negative, probably as much as minus 1.0% to 1.5%. This outcome is not even remotely close to neutral, not even in the same time zone. No balance is achieved when the amount required to borrow for a wide variety of loans overwhelms the amount contributed to savings. Therein lies the problem when the nation has no savings and invests most new capital in Asia.

In order to keep the charade going, the United States, its trading partners, and investors worldwide must be fooled, tricked, and deceived by myths. The myths help to obscure the wholly fallacious and destructive policies at work. Without such myths, we would be forced to endure a painful correction to inflated assets, and be subjected to a severe debt downgrade. In my analysis such a day is put off and delayed, not avoided and circumvented.

One could stretch the definition of US neutrality to include the entire global economy. Asian savings supplies capital for business investment in an attempt to seek balance. But it more realistically supplies credit within the United States for a deepening obligation of Medicare expenses, a rationalized shrug of tax structure levies, US Military war spending, a frenzied housing speculation, and broad bond speculation. Recall that our free market will lend money for anyone to pursue a dream, as long as you have the income. NO WAIT!!! Housing loans only require a good solid credit rating in many cases. So a person with a sterling credit record can conceivably borrow almost endlessly even after walking away from the employment bridle, bit, and yoke. The balance has a self-dealing nature about it. The Asian savings has as its origin the US bank system largesse, pure federal monetization and private sector credit creation, which produces mountains of trade surpluses for exporters in the Far East. Money off the US inflation printing press becomes transformed into Asian savings. It is not savings at all, but rather evidence of capital draining (blood hemorrhage) collected in Asian central bank depositories (blood vats).

The USFed is caught in another bind of its own making, in seeking neutrality. They rely upon the GDP (gross data pollution) for economic growth measurement and CPI (constant price index) for guidance on the effect on chronic inflationary policy. They react to the housing bubble like a dog chasing its tail, and have actually confused themselves. Greenspan has spent more time selling his policies than actually working to make them well studied and sensible. Thus, my label of him being the senator from the state of Wall Street. He has stated his goal of sustained economic growth against a landscape of tepid price inflation. If reality were introduced into the mix, one would have to admit that over half of GDP growth is the product of statistical fiction and creative accounting. See the recent "Three Great Big Lies" for details on how the US stat lab maestros have deceived us mightily. US ECONOMIC GROWTH RELIES UPON AN ABSURD PRICE DEFLATOR, one which actually claims that prices are rising more slowly than the broken CPI index. Raw economic activity numbers must be reduced by price inflation. The more slack the job done in adjustment, the more baseless and corrupted the claimed robust economic growth. Most economic growth is improperly and inadequately adjusted price inflation for materials, energy, and foodstuffs. Much of what we call economic growth is simply price inflation, without any doubt in my mind. We rag on about slow stodgy European growth, when they do not lie so systematically and pervasively. We lie institutionally, and in recent months, we lie without the cover of much credibility. Anyone with half a brain can see that half of US official statistics are dishonest. Anyone with a decent education can see that the majority of US official statistics are founded in promotional spin in order to sell our story and to attract foreign capital.

Furthermore, even by the USFed's own cry of neutral rates with respect to consumer price inflation, prices are rising much faster than rates. The annualized CPI jumps in Feb, March, April of 2005 were 6.9%, 9.4%, and 8.1% respectively, only to taper off a bit later in the spring after crude oil fell in price. It seems, in this Orwellian Age, we proclaim neutrality when we are nowhere near it. In the legal world, a device is often used to argue a case, using a "reasonable man" and his behavior, beliefs, and preferences. Well, no reasonable man or woman believes the consumer price inflation is actually under 5%, not in this world. Enough space is usurped is establishing the premise that the CPI vastly understates actual inflation. No more here. Let it suffice that the GDP is much slower than the 3.0% to 4.0% reported, and the CPI is much higher than the 2.0% to 3.0% reported. Take away the huff, puff, spin, and bull cookies, and even under the new neutrality guidelines, the USFed is way past neutral on the side of accommodation. If we ever reach neutrality, the interest rate will be so high that the US Economy will come to a grinding halt. Price inflation far exceeds economic growth. The inflation dependent system wants cheap money. We care more about the price of money than the price of real tangible things, and have the audacity to boast of its evolution and progress.

In my opinion, and bear in mind this is only my conjecture, founded upon a mix of professional analysis and personal judgment from many years of observation, the USFed has an unspoken goal which in no way does it wish to be made public. This view is hardly conspiratorial, but rather extremely practical. The US Economy has as its faulty foundation the housing sector. The vulnerability to our national economy, its vibrancy, its financial health is unspeakable and enormous.

As the USFed has raised short-term interest rates over a stretch of 14 months, the adjustable mortgage rate (ARM) has gradually risen. Owing to the Bond Conundrum, the long-term interest rates have remained tame, in defiance to Greenspan. For whatever reasons, actually thoroughly covered in my past writings, long-term rates have permitted the fixed mortgage rate to be roughly the same as a year ago. Ten basis points is insignificant to bring down the housing superstructures. The consequence to mortgages from the Fed tightening has been convergence of the ARM to the fixed mortgage rate, possibly their objective.

It is my contention that the USFed march to neutrality is achieved when ARMs are nearly equal to fixed mortgage rates. That is their unstated goal. At that point, homeowners can swap into fixed mortgages, lock their rates, and protect themselves from a potentially higher interest rate environment. It would be painful enough if housing prices go into decline. It would be doubly painful if household monthly costs were to rise at the same time, a doubly whammy to their balance sheets and monthly budgets.

In no way can Chairman Greenspan openly reveal this objective in monetary neutrality. That would be tantamount to an admission that the entire national economy rested atop a housing bubble. We all realize it, but cannot be told this. We all know the risks and danger when a structure is built atop unstable moorings. It has no foundation and no capstone. Watch for the Mad Maestro, the Pied Piper, the Wizard of Oz, the blatant charlatan, to urge homeowners into a swap from ARM to fixed mortgages. His urge to swap in fixed contracts will be the signal in my view that the Fed tightening cycle is at an end, and neutrality will be proclaimed. We need new measuring sticks when a nation has negative savings, when an entire economy is debt dependent and highly reliant upon inflating assets. Old tested meters cannot be applied. New meters can be loosely stated, provided not too much laughter ensues. Credibility must be maintained in order to preserve confidence in the absurd system. But the real meter comes from the basement bowels of the burgeoning housing bubble and its shifting sands of financial foundation.


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Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 23 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at

Jim Willie

Jim Willie

Jim Willie CB, also known as the “Golden Jackass”, is an insightful and forward-thinking writer and analyst of today's events, the economy and markets. In 2004 he launched the popular website that offers his articles of original “out of the box” thinking as well as content from top analysts and authors. He also has a popular and affordable subscription-based newsletter service, The Hat Trick Letter, which you can learn more about here.  

Jim Willie Background

Jim Willie has experience in three fields of statistical practice during 23 industry years after earning a Statistics PhD at Carnegie Mellon University. The career began at Digital Equipment Corp in Metro Boston, where two positions involved quality control procedures used worldwide and marketing research for the computer industry. An engineering spec was authored, and my group worked through a transition with UNIX. The next post was at Staples HQ in Metro Boston, where work focused on forecasting and sales analysis for their retail business amidst tremendous growth.

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