Boston Fed president Eric Rosengren, “with a straight face” talks about how the FED can affect the economy with nominal interest rates at zero:

I’ve called this talk “How Should Monetary Policy Respond to a Slow Recovery?” My answer to that question is: vigorously, creatively, thoughtfully, and persistently, as long as we have options at our disposal. And we do have options, despite having pushed short-term rates to the zero lower bound.

We think the FED’s options have been whittled away like the Black Knight’s in the Monty Python Movie:

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Robert Prechter writes (emphasis added):

Economists hint at the Fed’s occasional impotence in fostering credit expansion when they describe an ineffective monetary strategy, i.e., a drop in the Fed’s target rates that does not stimulate borrowing, as “pushing on a string.” At such times, low Fed-influenced rates cannot overcome creditors’ disinclination to lend and/or customers’ unwillingness or inability to borrow.

We would add some thoughts to this simple concept.  Prechter has emphasized credit expansion, but there is more to it than that. First, there is a difference between customers who are unwilling to borrow and those unable to borrow. Those unwilling to borrow are also likely unwilling to spend.  While those unable to borrow are likely to have few assets to sell to feed their desire to spend.   So… suppose the government bought all bonds, public and private, for (newly created) cash.  Those who would spend but who had no assets to sell would receive no new cash and would not spend more.  Those who had assets to sell will have received new cash in return for their bonds, but they didn’t want to spend in the first place.  Any one or more of those  individuals could have converted their close-to-zero yielding bond assets to cash and spent at any time, but chose not to.  Will one who is unwilling to borrow and spend suddenly become more inclined to spend and thus make prices rise, simply because the makeup of his portfolio was changed – against his will- from close-to-zero yielding bonds to absolutely zero yielding bonds?  The answer is unclear, particularly, if he expects prices to fall.  The FED might want to take a survey of these folks…

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Look at the photo of a dollar below:

See where it says “Federal Reserve Note” and where it says “This note is legal tender…”?   Dollars are notes or debts, that is, obligations of the Federal Reserve.  When the Federal Reserve buys US Treasury Bonds from the open market  and pays for them with dollars (a process some refer to as “monetization” or “printing money”), it and the marketplace has simply exchanged one form of debt for another.  The supply in the hands of the market of one kind of debt (dollars) increased while another (Treasury Bonds) decreased.   Long before the Federal Reserve got involved to exchange dollars for Treasury Bonds – when the Treasury bonds were first created and sold to the public – that’s when the notional value (that is, the proceeds) of those Treasury Bonds was attached to goods and services.  Increases in government debt, as well as increases in private debt (net), are inflationary.  But not the monetization of the debt by the Federal Reserve.

At present, we have a situation where private debt is being reduced faster than government debt is being increased so that, in aggregate, total debts are declining – this is deflationary.

Technically, the total supply of debt can increase in an amount equal to the amount which society saves each year without inflation.  Conversely, total debt (including new equity shares) must increase by the amount of savings each year, or… we will have deflation.

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You don’t have to be a bank to inflate or deflate.

Jimmy Songwriter sitting at the bar has a flash of inspiration and quickly writes down a new song.  His somewhat inebriated friend, Joey Songsinger hears the song once and enthusiastically offers to buy it for a price equal to “whatever it takes – even if it’s the whole income of the United States”.   Jimmy Songwriter, as a joke and to teach his friend a lesson, tells Joey he will sell the song for $13 Trillion and that he would finance it and Joey signs a note to Jimmy for $13 Trillion.  This single transaction goes on record as the highest price ever paid for a song… drives up the average price of all songs by a factor of thousands…and doubles nominal GDP  and the average price of all goods and services in the United States.  The next year at Christmas, when the note comes due, Jimmy sends his friend Joey an email offering to “settle” the note for $500.  Joey gladly agrees.  After all they both knew that’s what the song was truly worth …and what Joey could pay.  That year, nominal GDP falls from the previously inflated level by roughly 50% with a 50% deflation in the price level as there are no more songs sold (and financed) for such exorbitant prices.

Notice:

1. We didn’t need banks or the Federal Reserve to create the price inflation or the price deflation which followed.  All we needed was debt creation and then the subsequent de-leveraging and return to “normalcy”.

2. Neither Jimmy nor Joey had the legal power to “print” or coin “money” and they did not need it to affect the price level.

3. Most importantly, what Jimmy and Joey do can offset and overwhelm whatever the Federal Reserve and the banks do.

John Mauldin is in the “mild” inflation camp, while Bill Bonner is in the deflation camp.  Mauldin cites the elements resulting in a tendency toward deflation as rising unemployment, massive wealth destruction, decreased final demand, low capacity utilization, massive deleveraging and a very weak housing market. But, then he bravely argues that our powerful, benevolent Federal Reserve will allow neither Bonner’s deflation scenario…nor large rates of inflation as posited by Peter Schiff:

The Fed is going to do what it takes to bring about inflation (in my opinion). But they will not monetize US government debt beyond what they have already agreed to. If they need to “print money” to fight deflation, they can buy mortgage or credit-card or other forms of private debt, which have the convenience of being self-liquidating. Read the speeches of the Fed presidents and governors. I can’t imagine these people will recklessly monetize US debt. You don’t get to their level without having a stiff backbone.

Mauldin’s apparent  blind faith in an effective, competent, and non-captured FED seems out of character.  It’s probably not naivete’ , but whatever else it is, it’s dangerous advice to bet on a potent FED in these times.  For our own part, the elements supporting deflation, as listed by Mauldin, are outside the FED’s control.  If they were within the FED’s control the FED would never have allowed them to begin in the first place.

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A recent article in the WSJ talks of “China Nurtur[ing] Futures Markets in Bid to Sway Commodity Prices“:

Chinese leaders are concerned that their nation’s enormous economic expansion is becoming an excuse for foreign suppliers to inflate commodity costs. So, they hope to use their three futures exchanges to fight back.

Government officials say the country is positioning its futures markets to be major players in setting world prices for metal, energy and farm commodities. By letting the world know how much its companies and investors think goods are worth, China hopes to be less at the mercy of markets elsewhere.

Its easy to see why China would want to protect itself from recent large fluctuations in commodity (mainly oil) prices, when they spent $180 billion importing oil last year. They won’t have a very easy time doing it, however. China is still a communist government and they do not have a legal system in place to support futures contracts. None of them would be enforceable. There is also a huge policy bias towards large state-owned enterprises like China Oil. The Shanghai Futures Exchange won’t be an open, competitive, and effective market until small players in the exchange can get equal rights. The authoritarian Chinese Government policy makers (dictators) only allow the economy cake to grow on the condition that the largest piece is received by their friends in high positions at giant state-owned enterprises.

Unfortunately, just as the Chinese economy is manipulated by a small group of people, the US (and world) economy is manipulated in the same manner by the FED and entities like Goldman Sachs. China should be setting it’s sites on getting rid of Goldman Sachs instead of setting up its own pitiful exchanges. There is not much of a link between the HUGE fluctuations in oil prices and China’s steady increase in demand for oil (and other commodities). The true culprit and beneficiary behind these things is (government sponsored) Goldman Sachs. GS manipulated who would be rescued by with its immense amount of government cronies in Washington, successfully killing off its competitors, and then rode the energy curve up and down gaining huge rewards in the mean time.

If China’s goal is control and manipulate the biggest economy in the world (it is), all it has to do is take a look at the US’s Federal Reserve. We do it much better here in the states! We set up an authoritarian entity, claim that its “private” and separate from any form of oversight, then let it freely give out trillions of tax payer dollars to support whatever manipulative policy it desires! All without any of its skeletons coming back to haunt any elected officials.

The WSJ reports that the minutes of the August FOMC suggest a FED determined to put a bright outlook on a very uncertain situation.  Basically, the “recovery” depends on an increasingly unemployed consumer deciding to spend more to take the place of federal programs.

This “blurb” from the minutes (emphasis added) as quoted at Calculated Risk shows the FED recognizes that a “recovery” is based on little more than “hope” that consumers will become more willing to spend as a result of their recent “increase in wealth” from all the bank-manipulated stock market gains and some other things the consumer could care less about:

The new estimates of real disposable income that were reported in the comprehensive revision to the national income and product accounts showed a noticeably slower increase in 2008 and the first half of 2009 than previously thought. By themselves, the revised income estimates would imply a lower forecast of consumer spending in coming quarters. But this negative influence on aggregate demand was roughly offset by other factors, including higher household net worth as a result of the rise in equity prices since March, lower corporate bond rates and spreads, a lower dollar, and a stronger forecast for foreign economic activity.

The August FOMC minutes could as easily read something like: “The Federal Reserve believes that a substantial case can be made that the consumer will win the lottery and go on a spending binge later this year”…

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According to Rassmussen Reports, 75% of Americans support auditing the Federal Reserve. In contrast, only 9% of adults surveyed were against the idea of a FED audit. In the face of all this support, Fed Chairman Ben Bernanke is continuing to push back against the Federal Reserve Transparency Act, that would give the Comptroller General – the head of the Government Accountability Office – the power to audit the central bank.

Economist Dean Baker, who’s been a vocal critic of the Fed, recently commented:

“The country now has almost 25 million people who are unemployed or underemployed as a result of the Fed’s disastrous policies. Millions of people are losing their homes and tens of millions are losing their life savings. The country is likely to lose more than $6 trillion in output ($20,000 per person) due to the Fed’s inept job performance.”

The Federal Reserve Transparency Act MUST pass in order for our economy to recover for the long term. Contact your representative TODAY to show your support for the bill!

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Please read William Greider’s article in The Nation in its entirety. Here are a couple of pastes to wet your whistle:

This awkward reality explains the dilemma facing the Fed. It cannot stand too much visibility, nor can it easily explain or justify its peculiar status. The Federal Reserve is the black hole of our democracy–the crucial contradiction that keeps the people and their representatives from having any voice in these most important public policies. That’s why the central bankers have always operated in secrecy, avoiding public controversy and inevitable accusations of special deal-making. The current crisis has blown the central bank’s cover. Many in Congress are alarmed, demanding greater transparency. More than 250 House members are seeking an independent audit of Fed accounts. House Speaker Nancy Pelosi observed that the Fed seems to be poaching on Congressional functions–handing out public money without the bother of public decision-making.

A few months back, I ran into a retired Fed official who had been a good source twenty years ago when I was writing my book about the central bank, Secrets of the Temple: How the Federal Reserve Runs the Country. He is a Fed loyalist and did not leak damaging secrets. But he helped me understand how the supposedly nonpolitical Fed does its politics, behind the veil of disinterested expertise. When we met recently, he said the central bank is already making preparations to celebrate its approaching centennial. Some of us, I responded, have a different idea for 2013.

“We think that would be a good time to dismantle the temple,” I playfully told my old friend. “Democratize the Fed. Or tear it down. Create something new in its place that’s accountable to the public.”

The Fed man did not react well to my teasing. He got a stricken look. His voice tightened. Please, he pleaded, do not go down that road. The Fed has made mistakes, he agreed, but the country needs its central bank. His nervous reaction told me this venerable institution is feeling insecure about its future.

It’s time – once and for all – dismantle the FED.  The bank’s power must be castrated.

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Below is a copy of Hank Paulson’s prepared testimony for tomorrow’s (June 16th) hearings which will cover the assistance that FED’s provided to Bank of America (thanks Zero Hedge):

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