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Ghosts of depressions past

If there is anything that haunts the Fed chairpersons it’s the fear that they will be blamed for causing another Great Depression. Ben Bernanke, noted for his studies of the era, has said that the Fed did not do enough to prevent the calamitous 1930s depression. That position, undoubtedly, led to the Bernanke Fed implementing three quantitative easing programs, which more than tripled Fed asset holdings.

16 Nov 1930, Chicago, Illinois, USA --- Notorious gangster Al Capone attempts to help unemployed men with his soup kitchen "Big Al's Kitchen for the Needy."  The kitchen provides three meals a day consisting of soup with meat, bread, coffee, and doughnuts, feeding about 3500 people daily at a cost of $300 per day. --- Image by © Bettmann/CORBIS

Fed asset holding are nearly always bonds, which are purchased with money “created out of thin air.” Therefore, increases in Fed holdings are inflationary. Sometimes more inflationary than other times, but always inflationary.

There is much speculation about when the Fed will hike interest rates. When the perception is that a hike could be imminent, interest rates climb and stocks slump. When the markets think that any rate hike could be put off until 2016, stocks and precious metals prices rise.

Presently, stocks and the metals are in narrow trading ranges as there is no consensus as to what the Fed will do or when. The International Monetary Fund thinks that the Fed should leave interest rates alone.

The IMF fears that a Fed rate increase could “trigger a new rise in the dollar with destabilizing consequences globally.” In the past twelve months, the dollar is up 20 percent against a basket of key currencies. (Which is another reason why metals prices have been weak.)

According to a recent IMF “health check on the US,” central banks around the world need to prepare for capital outflows that most likely will occur if the Fed hikes rates and money flows to higher-yielding US bonds. The IMF sees the possibility of “a significant and abrupt rebalancing of international portfolios,” which could result in market volatility and damage to financial stability around the world.

This is the second public plea by the IMF in thirty days for the Fed not to hike rates anytime soon.

Minutes from the Fed’s June 16-17 Federal Open Market Committee meeting indicates division about what the FOMC’s next move should be. There are indications of pockets of strength in the US economy, but concerns about Greece and the Chinese slowdown were also expressed.

Truly, the Fed is the world’s central bank, and it does take into consideration not just the US economy but the world’s. Janet Yellen does not want the albatross of another worldwide great depression hung around her neck. I think the Fed will hold course on interest rates for the rest of the year. If so, stocks and metals prices should strengthen.

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