Questions for the Fed

Minutes from the FOMC meeting in June 2013 were released, showing a split in policymakers' opinions on the timing of halting the Fed's latest asset buying program (QE).  Here are some questions that should be asked of the Fed, particularly by Congress, but probably won't be asked.

1) If the Federal Reserve stops buying government bonds, who will buy the government's newly issued debt?  Will private investors pick up the slack?  Will foreign governments such as China and Japan add to their holdings?  Will interest rates rise?  Will Congress be forced to cut spending?

2) If the Fed stops buying mortgage-backed securities, will the big banks be stable?  Since last September, the Fed has been buying about $40 billion per month in mortgage securities, which is essentially a bank bailout.  Will the big banks now be able to survive without further Fed subsidies?

3) If the economy can barely grow with the Fed adding to the monetary base at a rate of about $1 trillion per year, what will happen when the Fed stops inflating?  Will the economy continue to grow?  Will there be any kind of a correction?

4) What happens if the economy starts to sink back into recession?  Will the Fed start another QE program, or will it let the economy sink?

5) What if the commercial banks decide to start loaning out more money and reducing their excess reserves?  Will the Fed allow this?  Will there be massive price inflation?  Will the Fed increase reserve requirements to prevent the banks from lending?

6) What are the consequences of allowing the QE program to continue?  What are the downsides?  Does this cause distortions in the marketplace?

7) What will the Fed do if long-term interest rates continue to rise?  At what point would the Fed step in and increase its buying of government debt?  Would the Fed allow interest rates to rise to 10% or above?

8) If the Fed believes it is doing a good job of managing the U.S. dollar, would Fed policymakers oppose legislation to allow competing currencies developed from the free market?

I don't expect most of these questions to be asked, at least not directly to Bernanke and other Fed officials.  And I am in no way suggesting that the Fed should step in if interest rates rise, if there is a recession, etc.  In fact, I believe that the Fed should stop all monetary inflation immediately.  I am only pointing out that the Fed has had an unprecedented loose monetary policy over the last 5 years, yet the economy isn't showing any signs of booming, except perhaps the stock market.  It is scary to think of how much malinvestment there is in the system and how bad the shakeout will be when the Fed does slow down or stop its monetary inflation.

I really don't think that Bernanke and the Fed know what to do.  Bernanke knows what to do in the sense that he will be retiring in January, but he will be leaving a messy situation for someone else to deal with.

I think we will eventually have to go through some kind of a deep recession/ depression for a major reallocation of resources.  It is going to be painful.  The Fed can only cover it up with monetary inflation for so long.  I don't think the Fed will risk hyperinflation.  At some point, it will stop buying government debt and essentially tell Congress that it is their problem.  Congress will have to cut spending.  The Fed may still have to bail out the big banks, but it will help the banks over Congress if it is a choice between one or the other.

In conclusion, I think gold and cash (digits) are the best investments right now.  Gold is your best hedge against inflation and cash is your best hedge against a major recession.