Saturday, October 23, 2010

When your only tool's a hammer ...

... all the world looks like a nail.

The above quote is attributed to Abraham Maslow, and it rings true time and time again.  In this particular case, I think it applies to The Federal Reserve.

News flash for those who have been living under a rock: housing prices have NOT been rising indefinitely (as many investment products were designed to take advantage of), and when this pyramid scheme began to unravel (I love mixed metaphors), a ton of things happened very rapidly.  Credit markets dried up; countless business plans that were based on aggressive growth failed; countless more projects dried up or did not get funded in the first place, and unemployment shot up above 10%.  The Fed pulled the biggest lever it could, and dropped its lending interest rates like a rock:


Look again.  The interest rate has been almost ZERO since January 2009.  Twenty months and counting.  Historically, it's usually around 5%, but was as high as 20% in March 1980.  Banks and other major financial institutions can borrow money for free.

This is a slightly indirect way of pumping money into the economy.  Allowing borrowers (big banks, in this case) to borrow money on the cheap is an attempt to loosen things up a bit in the financial markets, and hopefully stimulate new projects, new industries, and new jobs.

But it just hasn't been enough.  And here's the point of this post: the Fed is considering new ways of pumping more money into the economy.  They've got their hammer, and they're lookin' for nails.

What has been the result of the absurdly low interest rate over the past 20 months?

  1. It has probably stemmed the loss of jobs in this country.  Sorry, I don't have a definitely source to cite for that; it's just my opinion.
  2. It has not turned the economy around.  (See current unemployment rate.)
  3. Large companies, given the opportunity to borrow large amounts of money basically for free, have been investing in themselves and buying back their own stock.

Let me underscore that "buying back their own stock" point: there has been $258 billion dollars in stock buyback this year, compared to $52 billion at this time last year.  And they're getting the money to do it from Uncle Sam.

Imagine the corporate boardroom discussions, happening all around the US:

Chief Financial Officer: "Hey, we can get a loan from XYZ financial institution for $2 billion at 0.1% interest per year.  That's the lowest cost of money, ever."
Chief Executive Officer: "Sounds like a good deal.  I want each of my division leaders to examine what they could do with an extra $500 million this year."


Chief Financial Officer: "Boss, all of the divisions say they can start some projects, but can only estimate a return of 3-4% in the next year on our investment."
Chief Executive Officer: "What??!?  3-4% return on investment?  That's a miserable deal for our stockholders!  I expect our stock price alone will go up 10% this year!  Why would I invest in R&D at a 3-4% return when I can invest it in myself and make at least 10%?  The stockholders will be happier, too."

Hopefully I've made the point pretty clear by now.  The Fed has a hammer: the interest rate it sets when loaning Fed money to banks.  It's a really big hammer.  It can be very effective when the economy is chugging along.  But when it's sputtering, it's not a very effective hammer.

The road to recovery is not paved by giving money to corporations so they can buy their own stocks back.  That doesn't create new jobs, and it really only helps those people who already own vast amounts of stock.  It doesn't put bread on anyone's table that isn't already covered in filet mignon.  Instead, I think the Fed needs to find new ways to *directly* create new jobs, or provide better incentives that will push industry to create new jobs.  If the Fed can't do it, then stand back and let another government organization stimulate the economy.  This kind of "new thinking" isn't the message we've been getting from the Fed.

I'm worried about the "quantitative easing" measures that are bandied about now -- another fancy way of pumping money into the system.  They don't address the problem at hand, and they have a cost that we'll have to pay off (specifically, my generation) in the future.  And it didn't really work for Japan when they tried it before, but they're trying it again anyhow.

A hammer is a very poor choice of tool for a screw.  And the economy looks screwy to me.

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