On Nov. 8, 2007, Federal Reserve Chairman Ben Bernanke told the U.S. Congress that a decline in the exchange value of the U.S. dollar wouldn’t affect American citizens if they didn’t travel outside the country. Weeks later, the Fed chairman backtracked and admitted that the falling dollar was contributing to higher inflation and hurting the domestic economy.
In fact, since his first pronouncement, the dollar has fallen another 6 percent against the euro and the consumer price index has risen at its fastest pace since July 1991, excluding a temporary surge in the wake of Hurricanes Katrina and Rita in September 2005.
Now, it looks as if the Fed is leaning toward holding interest rates steady when it meets tomorrow.
Unfortunately, Mr. Bernanke has backed himself into a corner —inflation has failed to moderate, while consumer spending, manufacturing output, and business investments in capital assets have fallen. In addition, the employment situation has continued to deteriorate, and the housing market has shown few signs of improving.
The Fed’s seven rate cuts since last September — from 5.25 percent to 2 percent — have failed to stimulate the U.S. economy in any meaningful way or to prevent home foreclosures from rising to their highest levels ever.
Consumers’ inflation fears, according to the University of Michigan, rose in May to their highest level since February 1982. Not surprising, considering food and gas prices have risen 33 percent since Nov. 8.
Earlier today, the Conference Board said that its consumer confidence index fell in early June to the lowest level since February 1992.
MacroMarkets LLC reported that home prices in the U.S.’s 20 top metropolitan areas have fallen 15 percent in the past 12 months. On average, home prices are now at the same level that they were in 2004.
I expect consumers to continue to rein in their spending in the months ahead and for the U.S. economy to continue to grow at an anemic rate. There’s an increasing likelihood that the economy could enter a recession later this year, if we are not already in one.
I warned readers about the unintended effect that lowering short-term interest rates could have on the economy in an article on April 25 titled, “Fed Action Could Hurt Stocks, Economy.”
In that article, I said that Bernanke apparently didn't understand the negative consequences that drastic interest rate cuts would have on the economy. I warned that any further rate cuts would serve only to increase inflationary pressures, cause consumers to reduce spending, and lead businesses to cut back on capital investments.
FOMC Member Richard Fisher has also warned about the adverse effects of the Fed’s interest rate cuts.
Fisher told Bernanke and other members of the Federal Open Market Committee on April 30 that he “was concerned that an adverse feedback loop was developing by which lowering the funds rate had been pushing down the exchange value of the dollar, contributing to higher commodity and import prices, cutting real spending by businesses and households, and therefore ultimately impairing economic activity.”
Yet, the erudite Bernanke decided to ignore Fisher’s comments, and U.S. consumers and investors alike are now stuck between a rock and a hard place.
So, what’s the learned professor going to do next? My guess is that unlike the courageous Paul Volcker, who raised short-term interest rates to 14 percent in the early 1980s in an effort to put a stake through the heart of the inflation devil, Bernanke will choose to leave rates unchanged when the Fed meets on June 25. He’ll likely claim that the ongoing economic slowdown will EVENTUALLY resolve the inflation problem.
Bernanke may also blame others for high oil prices, rather than admit that the Fed’s rate cuts have largely been responsible for rising oil prices over the past five months. (Keep in mind that oil is priced in U.S. dollars. Therefore, when the exchange value of the dollar falls, oil prices rise).
If the Fed leaves short-term interest rates unchanged tomorrow, you can probably expect the prices of both industrial and consumer goods to continue to skyrocket in the months ahead and for consumer spending to decline sharply. As a result of the potential developments, stock and bond prices could fall sharply between now and the end of this year.
Click here for how you can protect your portfolio from Bernanke’s bad decisions and its consequences.
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