Benson's Economic &
Market Trends
Interest Rates Stay 'Real
Easy'
Jul 1, 2004
Richard Benson
The money spigot is wide
open and not only is money free, but the Fed will actually pay
anyone who wants to take a drink of this free money!
The Fed is raising interest
rates but continues an easy Monetary Policy. How can this be?
How can the nominal level of interest rate for Fed Funds be raised
from 1 percent to 1.25 percent while Greenspan is still considered
"easy?" The reason is this policy lives in a land of
"Inflation and Money Illusion." Money illusion occurs
when you give the consumer more money to spend, when it actually
buys less. The consumer is left thinking they still got something
for their new money because they are still thinking about yesterday's
prices. Because most people, including investors, can be fooled
this way year in and year out, inflation can continue to be used
by the world's central banks to cheat savers and subsidize borrowers.
Here's how it works. There are really two interest rates -
the reported interest rate and the "real interest rate."
The interest rate on Fed Funds has been raised but to understand
what the actual policy is, the Fed Funds rate needs to be adjusted
for Inflation. This inflation adjusted interest rate is what
economic scholars call the "real rate of interest."
After inflation, an investor would like to see if he really made
or lost money.
Now, if the Fed keeps the interest rate on Fed Funds below
the level of inflation, as they do now, anyone who can borrow
will actually owe less in real terms at the end of the year.
If a speculator can borrow at 2 percent, when inflation is actually
5 percent, the speculator's real rate of interest is a negative
3 percent! In this Money Illusion world, institutions such
as banks, Wall Street broker dealers and Hedge Funds, are stepping
up and borrowing and will increase their holdings in commodities
and precious metals that do well in inflation.
Since the Federal Reserve is in the business of providing all
the money anyone wants at the interest rate they fix, there is
no actual limit to how much money might be borrowed or how high
the resulting money growth might be.
To accurately gauge the Fed's policy with respect to interest
rates, it is important to understand that if the real Fed Funds
rate is positive, savers are getting something on their money
and borrowers actually have to pay something for it. If the real
Fed Funds Rate is negative, savers are getting robbed and borrowers
are getting subsidized. Investors should note that the Real Fed
Funds rate started the year at -0.93 percent in January and has
dropped to an even easier -2.01 percent in May! Surprise; the
Federal Reserve has been easing the first six months of 2004!
Recent data of the Consumer Price Index (CPI) is showing inflation;
a lot of it! The year over year CPI is up 3.1 percent and the
CPI for the three months ending in May, was 5.5 percent at an
annual rate.
Given the timing of inflation flowing into the United States,
the rise in the CPI on a year over year basis, is back loaded
into the end of 2004. The following chart is a highly likely
projected reading for the Real Fed Funds rate assuming: 1) for
the remainder of 2004, the monthly CPI fluctuates between 0.3
percent and 0.4 percent (which is less than the current monthly
rate of increase; and 2) the Federal Reserve raises the interest
rate on Fed Funds by 0.25 percent at its scheduled FOMC meetings
in August, September, November and December.
| Month |
June '04 |
July '04 |
Aug '04 |
Sept '04 |
Oct '04 |
Nov '04 |
Dec '04 |
| Fed
Funds Rate |
1.0% |
1.25% |
1.5% |
1.75% |
1.75% |
2.0% |
2.25% |
| Monthly
CPI |
0.3 |
0.4 |
0.3 |
0.4 |
0.3 |
0.4 |
0.3 |
| Year
Over Year CPI |
3.25% |
3.55% |
3.47% |
3.54% |
3.97% |
4.67% |
5.1% |
| Real
Interest Rates |
-2.2% |
-2.3% |
-1.9% |
-1.8% |
-2.2% |
-2.7% |
-2.8% |
Looking through this Money
Illusion, "Easy Al" can clearly continue to live up
to his name. Raising interest rates to a level lower than increased
inflation means that businesses, households and the speculative
community, will undoubtedly wake up to the fact that not only
will money remain free, but it is still being subsidized big
time.
When a consumer receives a "gift" by simply borrowing
money, it's hard to turn down the present. This gift of subsidized
borrowing will effectively drive up prices by encouraging these
same consumers and businesses to borrow, create new money, and
spend. The broad measure of M3 is rising at a 10+ percent rate
so far in 2004 and money growth and inflation are expected to
continue on the upside.
Money is created when borrowing takes place. Pay people to
borrow and, abracadabra, money growth and inflation pop out of
the Fed's magic hat. What a neat trick!
By the end of this year with year over year inflation at
5 percent, consumers who owe about $9 Trillion on mortgages and
consumer credit can borrow and spend $450 billion just to keep
their real level of debt, adjusted for inflation, the same. (Inflation
forgives old debt). Buying a house at ridiculously high prices
might work in the long run if the buyer locked in a record low
long-term fixed interest rate. Inflation will slowly but surely
forgive the mortgage on the house.
For the economy, current debt burdens have now reached levels
so high they can't be paid back from current cash flows in real
dollars. The Fed can only choose between system-wide bankruptcy
of debtors or a "measured debasement" of the U.S. currency,
allowing inflation to forgive old debt and raise wages, salaries,
corporate revenues and tax receipts. The money spigot is wide
open and not only is money free, but the Fed will actually pay
anyone who wants to take a drink of this free money!
Richard Benson
President
Specialty
Finance Group, LLC
Member NASD/SIPC
2505 S. Ocean Boulevard
- Suite 212
Palm Beach, Florida 33480
1 800-860-2907
eMail: rbenson@sfgroup.org
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321gold Inc
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