Is the Fed About to Sabotage the Markets?

by David EngstromSeptember 03, 2015

As September 17 approaches, the question burning on everyone’s mind is whether or not the Fed will give us our first rate hike.  I say, if they do, it would be tantamount to sabotage.  Generally, the Fed raises rates to strengthen the dollar.  But, when the dollar is already the strongest guy in the gym, what’s the point?

Sabotage eh!  Sounds like a strong word.  It’s right up there with attack, war and shots fired.  In recent days, these are the words used to describe China’s action to strengthen our dollar by devaluing their own currency.  The reaction by the markets was violent.  In just days, every index was shoved into correction territory.  Every day now investors sweat the next Chinese move.  It is said the currency war has begun.

So let’s take pause.  When the Chinese make a move that strengthens the dollar, fear grips the markets.  How then, can a move by the Fed to strengthen the dollar be considered any less lethal to a struggling market and economy?  It is clear to me a move to raise rates will wreck havoc on IRAs, 401ks and other savings and retirement accounts. 

Now consider our budget.  Even a small rate hike will devastate it.  In the world of servicing more than $100 trillion of debt, a rise in rates of even 25 basis points could increase our nation’s debt service obligation by $250 billion a year.  That’s being generous.  Some economists put our real national debt above $200 trillion when you consider unfunded liabilities, state and local debt and personal debt. 

Then consider what happens to all those bonds that currently sit comfortably in retirement accounts.  If the Fed raises rates, bonds currently held lose value and become less liquid.  Why would anyone buy your bonds that pay a lower rate than those newly issued cheaper notes?  Current bond values could collapse.  To the extent these bond values support $500 trillion of derivative debt, the effects of raising rates could be catastrophic.

For these reasons, I see it nearly impossible for the Fed to raise rates any time soon.  I say “nearly’.  The only way I can see a rate hike in our near future is if the Fed is standing ready to take counter measures once the fallout of their actions is realized.  The Fed still has over $4 trillion on its balance sheet.  In March, in various interviews, Alan Greenspan alluded to the balance sheet, suggesting the Fed has $4 trillion bullets left in its gun.

Liquidating the balance sheet and pumping the proceeds of such into the economy would be the mother of all stimulus.  Again, according to Greenspan, if this occurred, it could bring about inflation so great it would quadruple the cost of living for the average family.

In a recent interview, Ray Dalio, founder of Bridgewater Associates, seems to share these views.  It is his opinion, the next big move by the Fed will be to loosen monetary policy not tighten.  Many others are of like opinion.  Indeed, the markets appear to be begging for it.  Why else would so many fund managers sell into the news that China is making moves to strengthen our dollar.

If a currency war has truly begun, don’t surrender quite yet.  The dollar is still the world’s reserve currency and the presses can still print.  However, I think return fire by the Fed in this currency war will require a different tact - one used 10 times by the Maestro himself during his tenure as Banker in Chief. 

What if the Fed intervened in foreign exchange and spent trillions of dollars to buy foreign currencies?  That would strengthen any currency bought while, at the same time, weakening our own dollar. 

The Maestro himself did it.  From Federal Reserve of New York records we learn, “The United States intervened in the FX market on eight different days in 1995, but only twice from August 1995 through December 2006.”  Now you know why he has been dubbed the Maestro.  Is the Fed about to dip into the Maestro’s old bag of tricks to explode the dollar bubble and unleash the inflation beast? Is this why Alan Greenspan said gold is going “measurably higher?”

As in any war, he who fires the last shot wins.  Don’t bet against the imagination and track record of the Fed.  But do realize what may be ahead and prepare for it.  Surely, if you do nothing you will become a casualty of the currency war.  There are two consequences ahead.  Either total collapse of our markets or inflation.  In either case, as history shows, I believe owning some gold and silver is your best protection against forces you cannot otherwise defend against.


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