You are viewing an archive of a previous version of Click here to browse current articles or return to the main site.

Is the Federal Reserve Running out of Ammo?

Is the Federal Reserve Running out of Ammo? 
By Ron DeLegge
August 12, 2010

SAN DIEGO ( – In certain cocktail circles, the Federal Reserve is being lauded for preventing the 2007-08 financial crisis from escalating into full-fledged pandemonium. 

In his recently published memoir, former U.S. Treasury Secretary Henry Paulson argues the government had no choice but to bailout major Wall Street banks. He declares the financial system was “on the brink.”

While the government may have succeeded in calming financial markets, at least for now, how ready is it for the next crisis? Are powerful institutions like the Federal Reserve running out of ammunition? 

Before we answer these questions, let’s look at what they’ve been up to.

The Great Recession Headache
As an extension of the U.S. government, the Federal Reserve Bank has thrown a few kitchen sinks and tables and chairs and household blenders at the ailing economy. It’s ordered interest rates to stay artificially low, it’s increased the money supply and it’s acquired radioactive assets that nobody else wants.

Yet, the housing market (NYSEArca: XHB) and the job market – two vital elements of a sound economy - still remain in shambles. Personally, I’ve never believed in a “jobless recovery” any more than I believe in “nutritious junk food,” “harmless explosives,” or “profitable losses.”

Regarding nationwide unemployment, even though the federal government’s headline number is an impressive 9.5%, that figure misses on a lot of levels. 

For example, it omits discouraged workers and forced part-timers. Excluding them would be unfair discrimination, not to mention misleading. And because the Bureau of Labor Statistics doesn’t included another category of the workforce known as “self-employed unemployed workers,” adding them to the mix would bring nationwide unemployment probably closer to 20%. Does that sound like an economic recovery to you? If you’re the employed economist authoritatively quoting the statistics, then it is.

1 + 1 = 4
The recently passed “Health Care and Education Affordability Reconciliation Act of 2010” offers an excellent case study in fuzzy math. According to the government, the bill will cost $940 billion over the first 10 years and reduce the deficit by $130 billion during that period. Put another way, the government plans to save $130 billion by spending $940 billion. How is such great financial acumen accomplished?

According to the Wall Street Journal, the U.S. government will “borrow one of every three dollars it spends” in 2010. In other words, the general game plan is for the government to borrow its way out of debt. And over the next ten years, budget deficits are projected to be $8.5 trillion. While this number is big, it’s not nearly as frightening as the unfunded liabilities of Medicare and Social Security.

If you still don’t understand what any of this means, you’re not alone. Try this: Tell your family that you’re going to spend $500,000 to save $5,000 and see how they react. If they throw you out of the house, you can blame this article.

Running Low on Ammo
The financial crisis in Europe (NYSEArca: VGK) offers strong lessons for all. The European Union (EU) (NYSEArca: FXE) along with problem countries like Greece gave too many excuses and waited too long to tackle over-borrowing, over-spending and financial shenanigans. Could any of this been prevented? How do you help an inoperable patient? “You call in the undertaker to dress up the cadaver with a trillion dollar plan nobody knows how to execute,” says a voice from the peanut gallery.

Heading into the 2007 downturn, the Fed and government had plenty of ammunition to fight an economic collapse. The budget deficit was a mere $160 billion and the federal funds rate was at 5.5%. Today the Fed’s $2.3 trillion balance sheet and the government’s $1.4 trillion deficit leave both with very little financial flexibility. And lowering interest rates again is out of the picture too.

In short, the Fed’s potency for tackling another meltdown has been severely weakened. Liberal monetary policies have certainly delayed the inevitable, but can it eliminate the inevitable?

Re-thinking Your Safety Net
Those that rely on the government to protect and defend their financial interests are likely to be badly disappointed. Now more than ever, it’s important to have the right mix of investments within your portfolio. Is your portfolio ready for what lies ahead?

Regardless of what policymakers decide, ETFguide’s Ready-to-Go Portfolios offer a different mix of ETFs to help you get ahead during these turbulent times. Which asset classes are best positioned for the storm ahead? The ingredients are readily available, now it’s up to you to execute the recipe.   

CommentsAdd Comment

keller said on August 13, 2010
  The $900 billion Healthcare Act will be repealed when Democratics are booted out of office this coming November. It will be replaced by something equally foolish. The emperor has no clothes and neither does the Federal Reserve or any other government agency for that matter. It's more than just being short of bullets - they're shooting in the dark.
JCwhit said on August 12, 2010
  Agreed and good points. The Federal Reserve's ability to curb another large crisis is less limited than before. Still, we shouldn't underestimate their ability to fidget with monetary and economic policy to absolutely distorted proportions. It's difficult for the average investor, person or whoever to guage where exactly we're at in this cycle. Just how many more bullets are left in the trigger? Does anyone have a clue? I don't think anybody really knows the answer, not even the Fed or the government itself. That's why "fed watching" is a wasted exercise in my humble view.
cecilb said on August 12, 2010
  Hi Ben,
Thanks for the reminder that we shouldn't "fight the Fed."

That said, we like your plan to buy U.S. Treasuries but the beard is still a little too Civil Warish.
BenBernanke said on August 12, 2010
  Don't fight the Fed!
Your Name:
Your Email: (Email will not be displayed anywhere)
Verification Code: