In a move that had already been well telegraphed, the Federal Reserve (FED) raised the discount rate from .50% to .75%. Is this the beginning of a new tightening cycle? NO! What readers of "Marko's Take" already know is that any major upward move in rates is not in the cards for 2010.
Reason 1 is the size of the National Debt, which had its ceiling recently raised by Congress to in excess of $14 Trillion! A 1% increase in rates translates into an additonal $140 billion per year increase in our budget deficit! Reason 2 is that the economy is NOT in a recovery, but slipping into the second dip of this "Double Dip Hyper-Inflationary Depression". Any material increase in rates is just not going to happen.
Furthermore, for any "tightening" to occur, the FED must raise rates FASTER than the increase in inflation. The "real" interest rate is defined as the prevailing interest rate MINUS the ongoing inflation rate. Historically, real rates have been slightly positive - about 2%. However, at the present, real rates are NEGATIVE and given the latest release in the Producer Price Index (PPI), a meager .25% increase in rates still keeps the FED way behind the curve.
Negative real rates were a FED policy blunder in the 1970's. The result was Stagflation and a mania in Gold. Fast forward to the 2010's and HISTORY WILL REPEAT!
The FED's move may also have been a token measure to appease China, which has been vocal in its displeasure with U.S. monetary policy and the debasement of the dollar.
Foreign owners of US government debt reduced their holdings by the largest monthly amount ever in December, with China offloading so many Treasury securities that it is no longer the largest foreign holder! Total foreign holdings of treasury securities plunged by $53 billion in December. China led the sell-off, reducing its holdings by $34 billion, while Japan increased its holdings by $11 billion to become the new largest foreign holder of Treasuries.
China has increased their holdings of U.S. Treasuries eight-fold over the past decade, so this latest dumping is relatively small in the grand scheme of things. It is newsworthy only in the fact that China is no longer the largest holder of Treasuries and this could be the beginning of a much larger trend to divest of U.S. debt.
The discount-rate move didn't affect the FED's main policy tool, the federal-funds rate, a FED-influenced rate that banks charge each other on overnight loans. That benchmark rate filters through to other market rates. The FED on Thursday reiterated the fed funds rate will remain near zero for an "extended period," which means at least a few more months.
So, while the FED has taken this rather minor move, the big picture remains unchanged. The FED is far more concerned about NOT derailing the incipient "recovery" it maintains is taking place. What recovery?
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