By Anthony Mirhaydari
On Wednesday, a handful of souls at the Federal Reserve will once more decide the path of interest rates in this country. After September's surprise "no taper" decision — where Bernanke and company decided to keep the $85 billion-a-month QE3 money pump going out of fear of the fiscal fight in Washington — Wall Street doesn't expect any major changes until January or March at the earliest.
And that's good news not just for us, but for the global economy as well. Because despite the scary long-term risks of what the Fed is doing by printing so much cheap money — and by extension what the Bank of England, the European Central Bank, and the Bank of Japan are doing too — the last few months have proved we just can't handle an increase in borrowing costs.
The economy is too fragile after suffering a rise in 10-year Treasury yields from 1.7% in May to 3% in September.
That kicked 30-year mortgage rates from 3.4% to 4.6% in a hurry, and sucked the wind out of the housing market. Pending home sales dropped 6% in September over August, nearly 2% in August over July, and has fallen for four consecutive months. On a year-over-year basis, pending sales are down 1.2% for the first negative reading in nearly two-and-a-half years.
It's not just housing. Core durable goods orders came in soft as inventories swell. That pushed the annualized three-month change down to -8.4% — the second-weakest result since the recession ended. Industrial production will likely be scaled back in the months to come in response.
And consumers are understandably nervous. The University of Michigan Consumer Confidence survey dropped to its lowest level since December 2012 as fears over the government shutdown, and its economic impact weighs on the minds of regular Americans heading into the holiday season.
The index, at 73.2, is down nearly 12 points since its recent peak in July (85.1) with consecutive declines since then.
No wonder then that growth personal-consumption expenditures, shown in the chart, have slowed to a pace that matches or falls below the levels seen during every recession since 1960.
When the Fed first started hinting that it could pull back on QE3 in May — which started last September and is the latest in a line of long-term bond-purchase programs that has taken the monetary base from $800 billion pre-crisis to nearly $3.7 trillion now — everyone sort of freaked out. Stocks dropped 6% in the first significant decline in six months.
Then came the fantasy that made the economy was strong enough to justify the move. Clearly, it's not.
Although the Fed is pushing the stimulus harder now than it was at the height of the financial crisis in 2008, it's getting less and less traction. According to IMF data, the economy is 4.5% below its full potential. That output gap is extremely deflationary, since it represents idled workers and vacant factories.
No wonder then that the annual core consumer inflation rate has inched lower for the last three years and stands at just 1.8%. When a society is as heavily indebted as ours is, low inflation is bad news since it increases the payoff burden of credit cards, mortgages, and the like.
Globally, the world is vulnerable to an increase in U.S. borrowing costs as well. The market taper tantrum hit emerging markets particularly hard, with currencies falling, and foreign equities roiled by a withdrawal of capital as money flowed back into the United States.
Decades of monetary maleficence, malinvestment, and credit consumption have brought us to this. Doped up on cheap-money morphine, the economy is too weak to handle the pangs of withdrawal. But the longer we stay on this path and continue the greatest experiment in monetary policy the world has ever seen, the risks the Fed and other central banks lose control grows.
One escape plan, which I recently wrote about, would be for the Fed to "reset" the situation by converting its Treasury bond holdings from debt to equity or equity-like assets. The Fed could elect to convert its holdings into zero-coupon perpetuity bonds, for instance. I don't see how the Treasury could say no. And that would effectively wipe trillions from the national debt and reinvigorate efforts to invest in infrastructure, energy, and medical research.
Federal Reserve vice-chair Janet Yellen, who is President Obama's pick to succeed Ben Bernanke as chairman, has spoken frequently on the concept of the output gap. A Yellen Fed will err on the side of more stimulus, not less, and could push the taper back indefinitely.
That's why I continue to recommend precious-metals positions to my clients, as both gold and silver benefit from the realization that more money printing, not less, lies ahead and the weakness in the U.S. dollar that will result. Positions include IAMGOLD /zigman2/quotes/209642463/composite IAG -4.44% , which is up 15% since I added it to my Edge Letter Sample Portfolio on Oct. 17.
Disclosure: Anthony has recommended IAG to his clients.<BREAK />