The Federal Reserve's Next Steps

Larry Edelson

Fed Weapon #1: The Fed can print as much money as it wants. There is no limit to how much it can print. Period.

Fed Weapon #2: The Fed can also begin buying stocks and real estate for its own account. Or, it can buy commercial paper, corporate bonds, index futures. You name it. There is nothing to prevent the Fed from doing any of that.

Fed Weapon #3: The Fed can lower the bank reserve requirement — which is currently 10% for all bank liabilities over $58.5 million — all the way down to zero.

Fed Weapon #4: The Fed could penalize banks for not lending to the economy.

For instance, right now the Fed pays banks 0.25% on the excess funds they park with the Federal Reserve, funds that are above and beyond what is required to be held at the Fed as reserves.

Instead, the Fed could simply do a 180 — and tell banks that it is no longer going to pay them any interest on their excess reserve funds, forcing the banks to invest or lend their reserves.

The Fed can even go a step further, and effectively tax or penalize banks for not making loans out to the general economy.

Fed Weapon #5: The Fed can continue to engineer a “default on the sly” on all government obligations, effectively inflating away America's debts, by DEVALUING THE U.S. DOLLAR, forcibly and clandestinely.

That's ongoing. Don't kid yourself just because the dollar recently rallied against the euro. It's still sliding against the Swiss franc, the Aussie and Canadian dollars, the Japanese yen, the Singapore dollar, and other Asian currencies.

There are even other weapons the Fed can use.

  It can cap interest rates on long-term Treasury debt. It did this before in the 1940s, where it capped the long-term Treasury bond yield at 2.5%, ending the cap with the Federal Reserve-Treasury Accord of 1951.

It effectively did the same thing in the 1960s when the Fed manipulated the yield curve by selling T-bills and purchasing an equal dollar amount of Treasury notes to reduce long-term rates.  

  It can even reduce interest rates on corporate securities, by printing up money to hand to the U.S. Treasury for it to purchase corporate securities.

  It can purchase foreign government debt, by printing dollars, then selling those dollars to buy Japanese bonds, euro debt, or what have you. Essentially, this is another way of devaluing the U.S. dollar.

And more. Keep in mind how Bernanke thinks. In his own words, Bernanke believes that the dollar devaluation of 1933-34 was an “effective weapon against deflation ... the devaluation and the rapid increase in the money supply it permitted ended the U.S. deflation remarkably quickly.”

Bernanke also believes that “a central bank whose accustomed policy rate has been forced down to zero has most definitely not run out of ammunition ... a central bank ... retains considerable power to expand aggregate demand and economic activity even when its accustomed policy rate is zero.”

In short, the Fed can do whatever it wants, whenever it wants. So it does have plenty of ammo left, just as I said it did way back in September of last year.

In fact, in my opinion, the Fed's battle against the financial crisis (and deflation) is just in its beginning stages.

The big question is whether the Fed's actions will solve or alleviate any of the consequences of this great financial crisis.