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News Link • Economy - Economics USA

Taxmageddon−It’s Worse Than It Sounds

• FinancialSense.com

Despite all ofthe Federal Reserveʼs interventions, the U.S. economy remains moribund. To borrow a term from Lord Keynes, the Fed is “pushing on a string.” Instead of trickling through to the general economy, the trillions of dollars that the Fed has injected into the banking system have either stayed with the banks in the form of excess reserves at the Fed (note the “hockey stick” on the chart below) or have gone into the financial asset markets, causing the “wealth effect” of rising stock prices. The economy, however, has not benefited from these huge influxes of newly created currency.

 

 

 

 

The problem that the Fed faces is how to increase the velocity of money, i.e. how often dollars change hands. Normally, the Fed accomplishes this through “inflation expectations,” that is, folks spend money now because they fear that their dollars will have diminished purchasing power in the future. With consumers and businesses racked by fears of uncertainty, this tactic is not working.

 

The crisis in Europe presents other problems for the Fed,besides the European contagion spreading to our own banking system and financial markets. First, the current flight to safety away from Europe and into the dollar is causing the dollar to strengthen, making the American exports more expensive on the world market. Second, Europe accounts for about 22 percent of American exports. A disruption in Europe means a dampening of demand for American exports. These two facts are a double whammy for theAmerican export market, one of the few bright spots of our economy. You can bet that Bernanke, et al, are closely monitoring Sundayʼs Greek election.


 

 

And donʼt forget that this is an election year. Since the Great Depression, no sitting president has ever been re-elected with a headline unemployment rate north of 7.4 percent. Currently, U3, the “official” unemployment rate, stands at 8.2 percent. You can make another bet that the White House is putting massive pressure on the Fed to “do something.”

 

The election places the Bernanke in a political dilemma. If the Fed does nothing, Democrats will accuse Bernanke of undermining President Obamaʼs campaign. If the Fed acts too blatantly, Republicans will accuse him of helping Obama. For this reason, the Fed will not want to embark on any serious monetary interventions too close to November. But, since there is a lag between the time the Fed injects money into the banking system and before the money has the desired effect on the economy, if Bernanke believes the economy is going to deteriorate going forward, he is going to have to take action rather quickly.

 

One thing thatBernanke could do to increase money velocity is to stop paying interest on the excess reserves held at the Fed. But, with the economy in such fragile shape and Europe looking worse all the time, Obama may not have the patience for such a move to begin working.


As I mentioned above, monetary policy takes time to work. On the other hand, fiscal policy--tax and spending policy--works much more quickly.

 

The overall problem for the government is that individuals and businesses are not spending. The Fed--”the lender of last resort”--has made plenty of money available, but it is just sitting there. I wonder if a desperate Obama will propose making the federal government “the spender of last resort” a la FDR? What if the economy begins another downward spiral over the summer, following the pattern of the last couple of years, and Obama proposes a massive “stimulus” and jobs program?

 

But, you argue, the Republicans in Congress will block such measures and the debt ceiling will again be an issue by the Fall. This is true. For instance, the Obama campaign is running a new ad in nine swing states:  I have a jobs plan,and Congress should pass it now.

 

On the other hand, what if Obama doesnʼt need Congress to act? What if he could enact these policies under his own authority? He can. Yes, it would be a radical step, but he can.

 

Many of us libertarians freaked out over Obamaʼs executive order (EO)of March 16,

2012, National Defense Resources Preparedness. Basically, this EO authorizes the federal government to nationalize all private property and industries. Similar EOs have been on the books since the Cold War, but what is particularly disturbing about this on is that it allows the President to take these actions in “non-emergency” conditions [Sec.

201(b)].

 

However, what Ifind even more interesting for our purposes here is Part 3--Expansion of Productive Capacity and Supply. Under this section of the EO,the government is authorized to make loans to private companies with the Federal Reserve acting as guarantor of the loans:

 

 

 

PART III  -  EXPANSION OF PRODUCTIVE CAPACITYAND SUPPLY

 

Sec.301. LoanGuarantees. (a) To reducecurrent or projected shortfalls of resources, critical technology items,or materials essential for thenational defense, the head of each agency engaged in procurement for the national defense,as defined in section801(h) of this order, is authorized pursuant to section301 of the Act, 50 U.S.C.App. 2091, to guarantee loans by private institutions.

 

(b) Each guaranteeing agencyis designated and authorized to: (1) act as fiscal agent in the makingof its own guarantee contracts and in otherwisecarrying out the purposes of section 301 of the Act; and (2) contract with any FederalReserve Bank to assist the agency in serving as fiscal agent.


(c)Terms and conditions of guarantees under this authority shall be determined in consultation with the Secretary of theTreasury and the Directorof the Office of Management and Budget (OMB).The guaranteeing agencyis authorized, following such consultation, to prescribe: (1) either specifically or by maximum limits or otherwise,

rates of interest, guarantee and commitment fees, and othercharges which may be made in connection with such guarantee contracts; and (2) regulations governing the forms and procedures (which shallbe uniform to the extentpracticable) to be utilized in connection therewith.

 

Sec.302. Loans. To reducecurrent or projected shortfalls of resources, critical technology items, or materials essential for the nationaldefense, the head of each agency engaged in procurement for thenational defense is delegated the authority of the President under section 302 of the Act, 50 U.S.C. App. 2092, to make loans thereunder. Terms and conditions of loansunder this authority shall be determined in consultation with the Secretary of theTreasury and the Directorof OMB.

 

In summary, President Obama (or a future president) could declare that current economic conditions represent a threat to national security and using the powers he gave himself with this EO, he is authorizing the Federal Reserve to make loans directly to certain businesses to stimulate the economy and promote job growth, thus bypassing the Fedʼs traditional method of injecting money into the banking system, and instead injecting the money directly into the economy.

 

Would any President attempt such a radical step? Probably not, but then we never thought that GM would be nationalized either. In any case, the Fed and the government are going to have to address increasing money velocity at some point. While and increase in the velocity of money will lead to a short-term boom, with all the money that the Fed has already created, the end result is going price inflation like America has never seen.


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