FOMC Monetary Policy Decision – No Change :
On 4/27/2011 the Federal Reserve’s Federal Open Market Committee (FOMC) announced that it will continue expanding its holdings of securities that it had previously announced (November 2010). The U.S. central bank said it will complete its $600 billion worth of purchases in longer-term Treasuries / government bonds (QE2), by the end of the second quarter of 2011 (June 2011). It also said that it would maintain its existing policy of reinvesting principal payments earned from its securities holdings.
The Committee decided to also maintain the target range for the federal funds rate at 0% to 1/4%, as it continues to anticipate that economic conditions and subdued inflation are “likely to warrant exceptionally low levels for the federal funds rate for an extended period”.
The Federal Reserve also reiterated that its intent is to “promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate”. The Committee seeks to foster maximum employment and price stability.
FOMC Observations – Economic Recovery Proceeding, Commodity Prices Transitory :
The decision reflects the central bank’s observation that the economy is improving, but still faces challenges:
• Economic recovery is proceeding at a moderate pace.
• Overall conditions in the labor market are gradually improving, but unemployment rate remains elevated.
• Household spending and business investment continue to expand.
• Investment in non-residential structures remain weak.
• Housing sector continues to be depressed.
The Committee has observed further increases to the price of oil due to global supply concerns, as well as significant increases in commodity prices (in general). It acknowledges that inflation has “picked up in recent months”, but remains confident that “longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued”. It stated that the “increases in the prices of energy and other commodities have pushed up inflation in recent months. The Committee expects these effects to be transitory”.
What Has Occurred & What Is To Come – Core CPI, Inflation, Debasement of the US Dollar :
The Fed’s stance on interest rates and inflation are in contrast to other major central banks around the world (such as the European central Bank) that have already raised rates to battle inflation. The Committee sees little risk of a higher inflationary environment taking hold, and believes the increase in commodity prices are temporary. However, higher prices of commodities are likely to persist. If higher prices do persist, it will continue to raise the cost of inputs for manufacturers, which in turn will raise the prices of goods & services. We will likely continue to see higher price levels than we have in the recent past, as broader inflation continues to set in. Major companies such as Kraft, Nestle, Starbucks, Tim Hortons, Kimberly Clark, etc, have already announced price increases across their product lines this year.
The conflicting view of inflation (that economists & investors have, that differs from the Fed) has to do with the way the U.S. central bank uses core CPI to measure inflation. The Bank of Canada as well as other central banks use core CPI as a measure of inflation as well. Core CPI strips out volatile food & energy prices, and therefore is not suitable for investors & citizens. They are the items that people consume the most, and also need in order to survive. It makes no sense for the average Joe to measure inflation using core CPI. Contrary to popular belief, CPI is not a cost-of-living index and differs in important ways (US Bureau of Labor Statistics, Statscan). To gain a better understanding of the conflicting views of inflation and CPI, read the past article Understanding CPI & National Inflation Numbers [CPI Is Not A Cost Of Living Index].
As a result of increasing the money supply (from printing money which they did not and do not have) through stimulus money, bailouts, as well as excessive spending, the U.S. dollar has lost significant ground against currencies worldwide. After the Fed’s announcement on April 27th 2011, it declined to a three year low against major currencies. This is in contrast to hard assets such as commodities (gold & oil, for example), which have risen in price across the board. For a more in-depth discussion, read the 2008 article on How The Financial Crisis Will Affect The US Dollar, Inflation, Gold, and Oil Prices.
Although Federal Reserve chair Ben Bernanke indicated no rush to reverse stimulus, how would the U.S. actually attempt to solve its problem when it decides to? It must reverse the excessive money supply, which they have increased mainly through the purchase of US Treasuries (QE1). So to rectify the problem, they would basically sell Treasuries and then cancel out the money received for them, in order to remove the excess money printed (in simple terms). That would in turn strengthen the U.S. dollar. Bernanke acknowledged its importance in the press conference, and stated that a strong and stable dollar was in the interests of the United States and the world economy. The Federal Reserve would also obtain much of its money to solve its problem from its number one source of income, the taxpayers. One of the simplest methods of increasing its revenue, will be through increased corporate & individual taxes, decreased entitlements & benefits, as well as through increased interest rates.
The current debt level of the U.S. is about $14.3 trillion (just shy of its debt limit). Even with U.S. President Barack Obama’s $3.7 trillion 2012 budget (announced February 14 2011), in which he plans to reduce the deficit by $1.1 trillion over ten years through budget cuts, it also includes many tax hikes (some of which were previously rejected):
• Increasing taxes on capital gains & dividends from 15% to 20% (affects pension plans, retirees, anyone who has investments for retirement).
• Raising top marginal income tax rate.
• Raising death tax and reducing exemption amount.
• Capping itemized deduction values (mortgage interest, property taxes, contributions to charity, local income taxes, local sales taxes, medical expenses, employee business expenses).
• New bank taxes (banks will likely pass burden onto customers through higher fees, less perks, more difficult to obtain credit, higher rates, etc).
• New life insurance company taxes (will likely pass onto customers – higher premiums, more difficult to obtain insurance, harder to claim, lower claim amounts).
• New international corporate tax hikes.
• New taxes on energy.
• Increases to unemployment payroll taxes (affects anyone who works).
• Increases to tax penalties.
See the ATR (Americans For Tax Reform) site for full break down of tax increases:
Despite all the budget cuts and tax increases, it is not going to be enough to solve the problem! The U.S. has pumped massive amounts of money into the system. Don’t forget that the $600 billion QE2 purchase of Treasuries, does not include the capital needs of Fannie May & Freddie Mac. On 10/21/2010, the Federal Housing Finance Agency (FHFA) stated that it expects Fannie May & Freddie Mac will need an additional $221-$363 billion through 2013.
But don’t be so quick to blame president Obama for everything. Although he is not free of blame (spending under his watch has contributed to increasing the deficit), this mess started long before he became president. Over the decades a general sense of entitlement, excessive spending, greed, and other factors have spread across the United States.
For Investors & Individuals :
During the past couple of years, I have recommended that investors & individuals protect themselves against the impending effects of inflation, before the effects of inflation could be observed in household consumer prices. Acquiring assets that would keep pace with inflation and the rising costs of goods & services, and staying away from government bonds, were recommended.
Now that the effects of inflation have finally surfaced (can be observed by the layman), some people may be wondering if it is too late to protect themselves against its effects? I do not believe that it is too late. Although we can now see the effects through price increases in everyday items, the increases have only just begun. We have yet to see any significant changes to interest rates and retail bank lending rates in the U.S. or in Canada. However, such changes will likely be observed over the next few years. Investors & individuals can protect against the effects of inflation through the following:
• Invest in commodities, businesses, and other assets that will keep pace with inflation. Gold related assets is just one example that I’ve mentioned before. However it is a very popular one. For more information see the past article Why Investing In Gold Can Be Profitable, And When The Gold Bubble Will Burst. However, gold should not be seen as the only choice. Others include assets related to oil, silver, potash, wheat, cotton, etc. Such assets can be in the producers of the commodities (metal/mineral miners, etc). Investors should look for businesses that can pass price increases on to its customers. There are a wide array of options & tools available.
• Secure cheap credit while retail bank lending rates are still low. In Canada, retail rates have already started to move up slightly, and do not follow the Bank of Canada. On 4/4/2011 TD Canada Trust raised rates, with the other banks following suit.
• On the personal finance side of things aim to reduce excess spending and find more efficiencies. Spend on things that really matter (groceries, health, education), and cut back on luxuries/frivolous spending.
• Pay off debts that have higher rates of interest (credit card and personal lines of credit).
• Learn about investing, because you can only reduce & cut back on so much before there is nothing left to cut! Where to start? Look through the Table of Contents at the Investment Knowledge section or the older article on How To Start Investing.
Official FOMC statement from April 26-27 meeting:
Older articles mentioned / referenced:
• [7/15/2008] How The Financial Crisis Will Affect The US Dollar, Inflation, Gold, and Oil Prices
• [3/20/2009] The Implications of The Federal Reserve’s Purchase of Treasuries (QE1): Inflation
• [11/18/2009] Understanding CPI & National Inflation Numbers [CPI Is Not A Cost Of Living Index]
• [12/30/2009] Federal Reserve Considers Selling Term Deposits
• [11/4/2010] Impact Of The Federal Reserve Buying $600 Billion More In Treasuries By Second Quarter of 2011 (QE2)
• [10/21/2010] Fannie & Freddie May Need Another $221 Billion Through 2013
• [11/02/2010] Why Investing In Gold Can Be Profitable, And When The Gold Bubble Will Burst
• [4/28/2011] TD Canada Trust Raises Rates
Thanks & Happy Investing! — The Investment Blogger © 2011