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Bernanke has bought into the double-dip recession position--FORBES



Fed's Next Move Will Be To Ease Interest Rates
Michael Pento, 06.22.10, 02:40 PM EDT
Bernanke fixation on deflation risks sparking inflation and a depression.




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The Federal Open Market Committee meets Tuesday to discuss its record-low interest rate policy. The announcement of the decision will be released on Wednesday. While no increase in interest rates is expected, there is little doubt among investors that the future direction for the central bank’s target rate will be up. In fact, Kansas City Federal Reserve President Thomas Hoenig has repeatedly expressed his desire to increase overnight lending rates to 1% from the current zero to 0.25% range by the end of summer.

At the same time, however, recent economic data--including the Philly Fed Index, first-time jobless claims and retail sales--are already pointing to a probable double-dip recession. Therefore, the Fed’s next move is more likely an easing than a tightening of rates.




The ease won’t come in any of the traditional forms. If the Fed were to reduce rates to a negative level, it would result in a politically unpalatable situation where depositors are charged to put their money into a bank. Nor will our central bank seek once again to dramatically increase the size of its balance sheet. Although the Fed bought another $7.34 billion in mortgage-backed securities last week, even Chairman Ben Bernanke won’t be foolish enough to buy up another $1.5 trillion of assets that he will not be able to dispose of in the future. (See Also: Investing In Precious Metals)

The Fed’s likely ease will involve zero interest on excess reserves: Since October 2008 the Fed has been paying interest on commercial bank deposits held at the central bank. But because of Bernanke’s fears of deflation, he will do whatever it takes to increase the money supply. With rates being near zero and the Fed’s balance sheet already at an intractable level, the only viable solution to fight Ben’s phantom deflation fear is for him to remove the impetus on the part of banks to keep their excess reserves laying fallow at the Fed.

If commercial banks stop being paid to keep their money dormant, they will find a way to get money out the door. They may even start shoving loans out through the drive-up window. Banks need to make money on their deposits (liabilities). If they don’t get paid by the Fed, they will be forced to take a chance on the consumer. After all, it has been made clear to them that the Fed and Treasury stand ready to bail out banks’ bad assets at any cost. So why not take a chance once again?

Following this month’s meeting, the FOMC is unlikely to indicate that the Fed will stop paying interest on commercial bank deposits. However, in the near future this strategy will be the most appealing method for the Fed to increase liquidity. Once Mr. Bernanke assents to the double-dip recession scenario, he will fight deflation by any means necessary.


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