The Fed is promising once again to pound nails with the only tools in its toolbox, a saw and a chisel. The "nails" the Fed is trying to pound down are unemployment and deflation. Needless to say, whacking these big nails with a handsaw and a chisel is completely useless: they can't get the job done.

The Fed claims all sorts of supernatural powers to sink nails at will--"unconventional monetary policy," quantitative easing, money dropped from helicopters and so on. But all it really has are two tools which have no positive effect on unemployment or the real economy.

1. The Fed can manipulate interest rates to near-zero

2. The Fed can shove "free money" to the banks

That's it. That's all the tools the Fed has in its toolbox. Let's consider what these tools accomplish in the real world.

Zero interest rates do not cause potential employers to hire unemployed people. Zero interest rates incentivize financial speculation (yield-chasing via trading risk assets) and malinvestment in projects that would be marginal if rates were normalized.

If capital cost 10% to borrow, only high-quality, low-risk ventures would attract funding or qualify for a loan. At 1% interest, the borrowing costs are so low that all sorts of high-risk, marginal schemes can afford to float loans.

Low interest rates also lead to money flowing to marginal borrowers. If rates were 10%, only those with good credit, credible income streams and collateral qualify for loans. At 1%, marginal borrowers (the kind who are most likely to default) qualify for loans.

All the Fed accomplishes with zero-interest rates is to build up a new wave of borrowers who will default. The Fed's policy simply adds to the mountain of impaired debt that is crushing the global economy.

The Fed's zero-interest rate policy (ZIRP) has impoverished savers and pension funds and provided disincentives to capital formation. In its anxious rush to lower the cost of borrowing, the Fed has stripped hundreds of billions of dollars of interest income out of the economy, and punished those who accumulate capital (cash savings) that is the bedrock of capitalism (a meaningless myth now that the Fed and Federal government are central-managing the economy).

Talk about unintended consequences. The Fed's ZIRP punishes the prudent and rewards financier gamblers and encourages marginal borrowers who are tomorrow's defaulters.

Pushing "free money" to the banks was supposed to do three things: It was supposed to enable the banks to lend lots of money at a premium and skim enormous profits that could be used to rebuild their ravaged balance sheets.

It was also supposed to spur consumption and investment, because money was so "cheap" how could you refuse to borrow more?

Lastly, it was supposed to enable homeowners to refinance their underwater mortgages at lower rates, creating disposable income that the homeowners would then spend on Chinese-made TVs, clothing, etc., creating "growth."

As Mish Shedlock often points out, you can't force people to borrow money, and offering marginal borrowers more debt does not make them magically creditworthy. The truth is that 95% of American households have taken on ever-rising debt loads while their adjusted incomes have been flatlined for decades.

The Fed's "solution" to over-indebtedness and excessive leverage is more debt and more leverage. Financial media lackeys and assorted analyst-toadies keep proclaiming that "households have deleveraged" and are now ready, willing and able to take on a couple trillion dollars more of debt to buy stuff, but this is the usual propaganda of cherry-picking data to fit the happy story being "sold."

The top 5% have improved their debt-income ratios, but the lower 95% don't qualify for new loans or refinancing. Now that the banks are weighed down with bad debt and writedowns, they are wary of loaning more to marginal borrowers.

So the Fed's "free money" that it shoved to the banks sits in reserves. It's dead money. It isn't funding wonderful new enterprises that are hiring millions of unemployed workers, it's sitting as reserves, bolstering balance sheets, or it's funding trading-desk speculations in the foreign exchange, stock and bond markets.

Maybe trading desks added a few traders to play with the Fed's "free money," but that's like hitting the unemployment nail with a handsaw blade: it doesn't do anything in the real economy or the labor market.

Fed Chairman Ben Bernanke's famous "helicopter" from which he drops money into the economy is a misnomer. He can't drop money into the real economy; all he can do is drop it into the banks, where it languishes as reserves or is used to fuel speculative bets in global markets.

The Fed is powerless, as its tools have no effect in the real world. It can fuel "risk on" market rallies with its trillions in "free money," but it can't lower unemployment or accomplish anything in the real economy except rob savers and pension funds of hundreds of billions of dollars each and every year.

It's actually, pathetic, isn't it? Ben and the rest of the impotent board are uselessly banging away at nails with their handsaws and chisels, while claiming to be financial wizards with unlimited powers. The next time the Fed unleashes quantitative easing, maybe the citizenry will wake up to the fact the Fed's only power--to steal from savers in order to benefit insolvent parasitic banks--is actively destructive.

Read the Introduction (2,600 words) and Chapter One (7,600 words) for free.

We are like passengers on the Titanic ten minutes after its fatal encounter with the iceberg: though our financial system seems unsinkable, its reliance on debt and financialization has already doomed it.

We cannot know when the Central State and financial system will destabilize, we only know they will destabilize. We cannot know which of the State’s fast-rising debts and obligations will be renounced; we only know they will be renounced in one fashion or another.

The process of the unsustainable collapsing and a new, more sustainable model emerging is called revolution, and it combines cultural, technological, financial and political elements in a dynamic flux.

History is not fixed; it is in our hands. We cannot await a remote future transition to transform our lives. Revolution begins with our internal understanding and reaches fruition in our coherently directed daily actions in the lived-in world.

If this recession strikes you as different from previous downturns, you might be interested in my book An Unconventional Guide to Investing in Troubled Times (print edition) or Kindle ebook format. You can read the ebook on any computer, smart phone, iPad, etc. Click here for links to Kindle apps and Chapter One. The solution in one word: Localism.


Readers forum: DailyJava.net.



Order Survival+: Structuring Prosperity for Yourself and the Nation (free bits) (Kindle) or Survival+ The Primer (Kindle) or Weblogs & New Media: Marketing in Crisis (free bits) (Kindle) or from your local bookseller.

Of Two Minds Kindle edition: Of Two Minds blog-Kindle

---

"This guy is THE leading visionary on reality. He routinely discusses things which no one else has talked about, yet, turn out to be quite relevant months later."
--Walt Howard, commenting about CHS on another blog.

---

NOTE: gifts/contributions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, Cudick A. ($50), for your stupendously generous subscription to this site--I am greatly honored by your longstanding support and readership.

---

Or send him coins, stamps or quatloos via mail--please request P.O. Box address.

Subscribers ($5/mo) and contributors of $50 or more this year will receive a weekly email of exclusive (though not necessarily coherent) musings and amusings.

At readers' request, there is also a $10/month option.

The "unsubscribe" link is for when you find the usual drivel here insufferable.

Your readership is greatly appreciated with or without a donation.

---

For more on this subject and a wide array of other topics, please visit my weblog.

                                                           

All content, HTML coding, format design, design elements and images copyright © 2012 Charles Hugh Smith, All rights reserved in all media, unless otherwise credited or noted.

I would be honored if you linked this essay to your site, or printed a copy for your own use.

Terms of Service:
All content on this blog is provided by Trewe LLC for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at anytime and without notice.