Fed's Easy Money Policy Enriches Big Banks, Creating Bubble That Will Result in Crisis

When you hear news that the Federal Reserve is “raising interest rates” (which occurred just weeks ago), the Fed is, in reality, raising just one interest rate: the federal funds rate.

The federal funds rate is the interest rate at which banks and credit unions (depository institutions) lend the funds they keep at the Federal Reserve to other depository institutions overnight. In essence, it is an overnight lending rate from one bank to another.

As of this week, the federal funds rate was yielding 0.91 percent. Just six months ago, it was 0.30 percent. Meanwhile, the 10-year Treasury currently yields 2.42 percent. That arbitrage is a really sweet deal for the Big Banks. The Fed prints money and essentially gives it to the Big Banks, who then loan it back to the government at a much higher interest rate. What a racket!

Since late 2008, the nation’s biggest banks have been receiving enormous sums of money from the Federal Reserve at near-zero interest rates. They are then able to invest this essentially free money in government bonds, collecting massive returns in the process. This results in pure profit, which is one hell of a business model.

Yes, the Big Banks are in the supreme and enviable position of getting virtually free money from the Federal Reserve, which they then loan out at interest.

It's no coincidence that the stock market took off like a rocket when the Fed initiated its zero-interest-rate policy, along with three successive rounds of quantitative easing. The S&P 500 doubled in value from November 2008 to October 2014, coinciding with the Federal Reserve's asset purchasing program.

This has led to massive speculation and malinvestment, such as the recent Snapchat IPO, for example.

What’s particularly amazing is that the Big Banks are using this nearly-free Fed money to buy billions worth of Treasury bonds, redirecting this money right to the federal government for its deficit spending.

"Including federally guaranteed mortgage-backed securities, banks now own $2.4 trillion of government bonds, which would be the most since the central bank began compiling data in 1973," Bloomberg reported in October. Obviously, that total has only grown in the ensuing months.

Yet, those bonds are eventually paid back, at interest, with taxpayer money. The Big Banks enjoy massive returns while doing zilch. They have done nothing and created nothing. They are simply riding the gravy train at taxpayer expense.

Think about that; billions of dollars are being loaned to the biggest banks, essentially for free. Those Big Banks then use all that nearly-free money to purchase Treasuries that currently pay 2.42 percent - 3.00 percent (30-year), resulting in huge gains for the Big Banks.

What borrower doesn’t love near-zero percent loans?

The government also loves this arrangement because it provides a buyer for hundreds of billions in Treasuries. It's a pretty cozy relationship, don't you think? It's kind of like your dad loaning you money so that you can spend it in his store and boost his sales.

It’s also called insanity.

The Fed’s cheap money policy has enabled the inexpensive financing of speculative, levered positions by Wall St. In short, the Fed has been financing concurrent stock, bond and housing bubbles, the likes of which flattened the economy in 2008-2009. And we're still trying to recover from that. All bubbles eventually burst, usually with devastating consequences.

Near-zero interest rates for the better part of the last decade have crushed savers, compelling many to chase the higher yields found in the equities markets. Low rates have also spurred a new housing bubble, sending home prices soaring above the levels that led to the last crash. This is largely keeping Millennials and other first-time buyers out of the housing market.

Of course, the stock markets are called “risk markets” for a reason. The hunt for yield has created “irrational exuberance” among investors and ballooned markets that will inevitably encounter a pin.

Investor optimism is now at its highest level since 2000, according to the latest Wells Fargo/Gallup Index survey. The herd mentality has taken hold, which is always the time to run for the exits. Unfortunately, not everyone will fit through the door, and the losses will be enormous.

During the current bull market, which began in March 2009 and is the second longest in history, the Dow Jones has more than tripled. This won’t go on indefinitely. We’re long overdue for much more than a mere correction. When this bubble inevitably pops, the resulting blast will feel like a Category 5 hurricane.

As the old saying goes, pigs get fat and hogs get slaughtered. The Fed is leading the hogs right into the slaughterhouse and the Big Banks will profit from the massacre.

Outsized Defense Budget Poised to Become Even More Bloated

Let me state this up front: I’m glad the U.S. has the biggest, baddest military in the world and I hope it always stays that way. I have no problem with the U.S. being the top dog and the top spender, militarily.

The U.S. spends more money on its military, by far, than any other nation in the world. We’ve been No. 1 since the end of World War II and, in my estimation, that’s a good thing. I think we should always strive to remain No. 1.

However, I’m also in favor of fiscal prudence and responsibility. That’s why I’m concerned about Donald Trump’s call for a $54 billion increase in military spending in his recent Congressional address. Trump's new federal budget proposal calls for defense spending to jump 10 percent above its already world-leading level.

This increase would "push the Pentagon spending, already well beyond the Cold War average used to keep the now-defunct Soviet Union at bay, even higher,” writes National Security Analyst Mark Thompson.

The U.S. spent $596 BILLION on its military in 2015, according to the Stockholm International Peace Research Institute.

That was more than the next seven countries (China, Saudi Arabia, Russia, United Kingdom, India, France and Japan) COMBINED.

Yet, in fiscal year 2017, US military spending is budgeted for an increase to $617.0 BILLION. Additionally, veterans' spending is budgeted at $180.8 billion and foreign policy / foreign aid spending is budgeted at $55.8 billion. All together, total U.S. government spending for defense is budgeted at $853.6 BILLION.

If that seems like a lot of money, it's because it is.

U.S. military spending in inflation-adjusted terms is higher than it has been since World War II, according to Miriam Pemberton, a research fellow and defense expert at the Institute for Policy Studies.

Here’s the rub: the national debt recently topped $20 TRILLION, and it is growing daily.

"The most significant threat to our national security is our debt," former Joint Chiefs of Staff Chairman Adm. Michael Mullen famously declared in 2010. When the nation’s top military man said this, the national debt was just over $13 trillion.

Yet, the federal budget deficit is projected to add nearly $10 trillion to the federal debt over the next 10 years, according to projections from the nonpartisan Congressional Budget Office.

Congressional Republicans, who have long sworn their allegiance to fiscal prudence and responsibility, will have to find a way to explain, endorse and rationalize a surge in military spending at the same time they are pledging large tax cuts for individuals and corporations, as well as huge cuts to much smaller budget programs.

Aside from the deficit, tepid economic growth is also a concern. Over the next 10 years, real economic output is projected to grow at an annual rate of 1.9 percent. No country can continually grow its debts faster than its economy, without leading to economic crisis.

The Defense Dept. knows that the military budget is bloated and wasteful. Everyone in Washington knows it.

The Pentagon commissioned a study, released in January 2015, which discovered $125 billion in bureaucratic waste.

However, the Pentagon quickly buried the study because it feared “Congress would use the findings as an excuse to slash the defense budget,” according to the Washington Post.

"Pentagon leaders had requested the study to help make their enormous back-office bureaucracy more efficient and reinvest any savings in combat power. But after the project documented far more wasteful spending than expected, senior defense officials moved swiftly to kill it by discrediting and suppressing the results.

"For the military, the major allure of the study was that it called for reallocating the $125 billion for troops and weapons. Among other options, the savings could have paid a large portion of the bill to rebuild the nation’s aging nuclear arsenal, or the operating expenses for 50 Army brigades.

"But some Pentagon leaders said they fretted that by spotlighting so much waste, the study would undermine their repeated public assertions that years of budget austerity had left the armed forces starved of funds. Instead of providing more money, they said, they worried Congress and the White House might decide to cut deeper.

"So, the plan was killed. The Pentagon imposed secrecy restrictions on the data making up the study, which ensured no one could replicate the findings. A 77-page summary report that had been made public was removed from a Pentagon website."

There are two primary excuses for more and more military spending. One of them is jobs.

Military contractors — such Raytheon, Lockheed Martin, Boeing and Northrop Gruman, for example — almost always build their hardware in multiple states. That way the jobs are spread over multiple congressional districts. Since no politician ever wants to vote to kill jobs, this is a very clever strategy. Creating jobs wins elections, while cutting them is always a losing proposition.

The other rationale/excuse is that, “The bad guys are going to get us.”

The Military-Industrial Complex and its political cronies have always created, and they always will seek to create, international bogeymen to advance their argument for new weapons, new wars and the continual flow of military contracts to weapons makers.

The justification is usually draped in the flag and sold as a matter of patriotism. According to this argument, if you support the military, you support more military spending. That makes you a patriot — a real American. If you don’t support more military spending, you are anti-American and a traitor.

It’s all so irrational, bogus and transparent, yet this argument is continually and reflexively made anyway. Many Americans still fall for it and even endorse it.

However, more spending doesn’t make the military stronger, better or more able.

“The only way to strengthen our national security is not to spend more money,” says Lt. Col. Daniel Davis, “but rather to reform the way the Department of Defense does business."

"It boggles the mind that the DoD cannot account for the hundreds of billions of dollars a year that it spends," says Davis. "A full twenty-six years after a federal law was passed requiring all parts of the federal government to provide Congress with an audit of its spending, there remains only a single government agency that has not complied: the Department of Defense. Even after being publicly rebuked by the Senate in 2013 for this failure—and wasting billions of dollars on failed auditing software—the Pentagon remains noncompliant.”

The U.S. already has the most powerful, most deadly, most advanced military in the history of humanity.

Given this reality, is it reasonable or rational for the US to spend even more money on its military?

I think the obvious answer is “no.”

Fed Rate Hikes May Create Self-Fulfilling Prophecy

The Federal Reserve announced another quarter-point hike yesterday, following the same move in December. The increase brings the federal funds rate into a range of 0.75 percent to 1 percent.

The Fed said its decision was based on both realized and expected labor market conditions and inflation. Translation: the labor market has tightened to nearly full employment and inflation is finally starting to tick up after years of dormancy.

But beware: there have been 13 Fed rate-hike cycles in the post-WWII era, and 10 landed the economy in recession, according to David Rosenberg, Chief Economist & Strategist, Gluskin Sheff.

The current economic expansion, which began in June 2009, has now entered its 93rd month, surpassing the 92-month expansion of the 1980s. That makes this the third-longest in U.S. history. In records dating back to before the Civil War, only the expansions of the 1990s ('91-'01) and 1960s ('61-'69) were longer.

Throughout U.S. history, the gap between one recession’s end and the next one’s beginning has averaged just under five years. In other words, this expansion is getting really long in the tooth, which is a very uncomfortable reality.

The Fed is playing a very risky game by raising rates right now, with the belief that this expansion will go on indefinitely. It won’t. We are currently in the midst of concurrent stock, bond and housing bubbles, and all bubbles eventually burst. All of them.

The economy surely doesn’t look all that strong at present.

The Atlanta Fed just relowered its Q1 GDP estimate to 0.9 percent from 1.2 percent after seeing the BLS report Friday, as well as consumer spending and CPI data.

Real GDP increased 1.6 percent in 2016, compared with an increase of 2.6 percent in 2015. In other words, the Fed is tightening into an economic slowdown.

The strong dollar is constraining exports, which creates a drag on GDP. Last year the trade deficit once again eclipsed $500 billion, as it has for 12 consecutive years.

Federal Open Market Committee members say they expect to make two more hikes in 2017 and three in 2018.

However, continued rate increases during this time of economic weakness will likely be counterproductive. Don’t be surprised if/when the Fed is forced to reverse course and slash rates once again as the economy stalls or the next recession inevitably begins.

But in order to cut rates in the future, the Fed first had to raise the funds rate above zero, which it started to do in Dec. 2015. Now it at least has some breathing room when trouble eventually rears its ugly head once again.

That’s what this and the two previous rate hikes (in Dec. 2015 and Dec. 2016) were all about. However, they run the risk of creating a self-fulfilling prophecy.

In essence, these hikes could spur the very recession or economic crisis the Fed says it is guarding against. That would be the definition of irony.