Congressional spending and Federal Reserve policy have teamed up to lock the U.S. economy into a downward cycle that may lead to catastrophic failure if left unchecked. Both Congress and the Federal Reserve have taken reckless abandon in their recent attempts to insert the federal government as a solution to the country´s economic woes. Rapid response and common sense solutions are required to counteract these irresponsible practices.

With the increase in federal spending, and the latest passage of a debt ceiling increase by Congress and subsequent signing into law by the White House, interest in investing in U.S. Government securities, like treasury bills, has begun to decline. The increase in deficit spending has created a growing loss of confidence in the government´s ability to repay its loans and threats from credit rating agencies of a potential downgrading of the US’s credit rating. As interest in the bond market decreases, interest rates on bonds automatically increase creating a higher cost to the U.S. government to sell its debt.

The Federal Reserve’s loose monetary policy to finance deficits and suppress interest rates indirectly contributes to what is known as the “carry trade” against the U.S. dollar. By borrowing dollars on the assumption that the dollar will decline and then using them to buy commodities, investors reap higher profits when paying back the initially borrowed dollars. With the continued decline in value of the dollar, the incentive to use the carry trade is increased which leads to a growth in speculation that the dollar will continue to be devalued.

Separately, the Federal Reserve is essentially subsidizing financial institutions by setting the benchmark interest rate at 0%. This initially spurred an increase in financial institution investment in treasury bills to shore up their balance sheets – a practice that served as probably the most under the radar bailout packages in federal government history. The ability of financial institutions to take Federal Reserve dollars at 0% interest and invest them in federal treasury notes with a set interest rate, essentially meant that the federal government was simply handing the financial institutions an allowance (or bailout). The Federal Reserve paying interest on bank reserves is not a solution. Not only is borrowing nearly free money from the Fed to then loan funds back to the Fed at a higher rate immoral, this will force up interest rates on treasuries which, ironically, present policy is trying to prevent.

In the case of a 30 year bond, this was 4.7% as of 1/6/09. Whether by design or by accident, this will serve as a creative federal subsidy until, due to a climbing deficit and reduced faith in the government´s credit, these institutions find it too risky to invest in treasury bills and look elsewhere, or the Fed is forced to raise interest rates due to concerns about creating an artificial bubble for the financial industry, or in housing.  Either that, or the Federal Reserve will displace the market and become the exclusive buyer of treasuries.

The irresponsible lending practices of the Federal Reserve and the reckless spending levels of Congress will inflict greater damage than the country would have felt had the housing and financial institutions been allowed to find equilibrium on their own in the first place. The involvement of the federal government hasn´t saved the U.S. economy; it has simply prolonged and likely worsened the pain of the eventual economic reset. A structurally sound financial system shouldn’t need bailouts or rescues. Swift and steady action is required to help brace the country for a potentially worse decline.

Federal spending must be checked and reversed, including a plan to permanently eliminate the deficit and restore faith in the U.S. government´s credit, thus re-establishing confidence in the bond market. The Federal Reserve must also seek to raise interest rates to prevent inflation and offset any potential asset bubble bursting created as a result of the recent 0% interest rate. Entitlement spending must be decreased and non-essential programs phased out in order to help lessen the strain on the federal budget. All of these actions are necessary now to help soften, and potentially prevent, a predicted economic decline within the next 10-20 years.

Danny Tarkanian
Republican Candidate for the United States Senate
Tark2010.org

Here is a very good recent article that dovetails with this issue: Watchdog: Bailouts created more risk in system

Danny Tarkanian, GOP primary candidate for U.S. Senate in Nevada, will be issuing a statement on economic policy that will appear right here on CE.  From what I can tell, Team Tark “gets it.”

If we continue down the current policy path - with the Fed propping up the bond market through massive Open Market operations – there will be no floor underneath the dollar and no roof on interest rates.  Investors/lenders will be compelled to tack an inflation agio onto interest rates.  The Fed undermines the very bond market that it is trying to prop up in order to hold interest rates artificially low.  The beginning of the end will come when the short-end of the curve collapses even with Fed support.

The real issue isn’t even so much the direction of nominal prices, but what prices would otherwise be absent central bank manipulation.  Prices are not falling to reflect wages, thus curtailing the market from clearing.  The Fed’s efforts to prop up the bond market through more of the same poison that precipitated the illness in the first place has only served to delay the inevitable consequences that must eventually be reckoned with.  By delaying the inevitable, the inevitable will become much worse.

I look forward to posting Team Tark’s position statement.  I also invite every candidate – Sharron Angle, Sue Lowden, et al. - to submit a position statement on economic policy.