Tags: Fed | Cuts | No | Slowdown

Fed Cuts Won't Prevent a Continued Slowdown

Tuesday, 18 Dec 2007 02:55 PM

There's been a lot of talk lately about the "need" for the Federal Reserve to continue cutting short-term interest rates, and at a much faster pace, in an effort to prevent a potential recession.

Some stock market pundits have also stated that the Fed needs to increase the money supply so that commercial banks will have more money to lend to consumers and businesses.

I've been somewhat confounded by the money-supply proponents, because these so-called "experts" should be fully aware that the Fed sets its target for the Fed funds rate by affecting the money supply.

More specifically, as some of you know, the Fed helps to determine the supply of money that banks have available to lend (and therefore the level of short-term interest rates) by buying and selling U.S. Treasury securities in the open market.

When the Fed is interested in increasing the money supply, thus lowering short-term interest rates, it buys Treasuries. When the Fed wants to decrease the money supply, thus raising short-term interest rates, it sells Treasury securities.

The Fed can also increase the amount of money that banks have to lend — that is, increase the money supply — by lowering the amount of funds that commercial banks are required to maintain at their regional Federal Reserve Bank. This is known as lowering reserve requirements.

However, the Fed can't force banks to increase their lending, or force businesses and consumers to increase their borrowing.

The Fed also doesn't have any control over bank lending standards. Hence, increases in the money supply — and the resulting decrease in short-term interest rates — don't necessarily translate into an improvement in economic activity.

As I've told you on several occasions over the past few months, consumer debt levels are near record highs, employment growth is slowing, and consumers' expectations regarding future economic conditions are deteriorating.

In addition, manufacturing activity is continuing to slow and bank lending standards are tightening. Home values continue to fall.

So, my research indicates that the Fed won't be able to prevent the U.S. economy from growing at an anemic rate over the next couple of quarters simply by increasing the money supply and lowering short-term interest rates.

There are important statistics that support my views that increasing the money supply won't stimulate consumers into increasing their borrowing in order to continue spending on unnecessary consumer items, nor will lowering short-term interest rates lead businesses to spend more on capital investments.

Just look at the charts below. As you can see, the MZM money supply has increased at a rapid pace over the past year.

However, individuals and businesses alike have been holding much greater amounts of their funds in money market accounts, rather than spending or investing that money; in economic terms, the demand for money, the demand to hold money balances, have also increased.

(Note: The MZM Money Supply refers to currency and travelers checks held by the public, checking account and credit union balances, repurchase agreements at commercial banks, and both institutional and non-institutional money market accounts).

The velocity of money — an economic term that refers to the number of times per year that aggregate incomes are spent — also has fallen sharply and individuals have significantly reduced their investments in IRA and Keogh accounts.

So, I continue to urge you to ignore the so-called Wall Street "experts" who continuously try to persuade investors like you to keep buying supposedly "cheap" stocks even when a preponderance of evidence suggests that stock prices are headed lower.

By the way, while most investors had a bad day in the market yesterday, subscribers to our ETF letter had a good day as both our conservative and aggressive portfolios advanced in price while the major stock market indices continued to trend lower. Click here for a trial subscription to this service, which helps investors make money whether stock prices in general are rising or falling.

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DavidFrazier
There's been a lot of talk lately about the "need" for the Federal Reserve to continue cutting short-term interest rates, and at a much faster pace, in an effort to prevent a potential recession. Some stock market pundits have also stated that the Fed needs to increase the...
Fed,Cuts,No,Slowdown
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2007-55-18
Tuesday, 18 Dec 2007 02:55 PM
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