The Latest Fed Statement

26 March, 2007 – It is a basic premise of today’s fiat-currency-based monetary system that central bankers only tell you what they want you to hear. For example, the Financial Times reported on March 23rd that “The explosive growth of credit derivatives has strengthened the US financial system, making it more efficient and more resilient, two Federal Reserve governors declared on Thursday.” Yes, these are the same derivatives that Warren Buffet called “financial weapons of mass destruction”. What else would you expect central bankers to tell us?

If this premise about telling us only what they want us to hear was not true, central bankers wouldn’t hold their meetings behind closed doors, out of public view. But they do.

So instead of watching their proceedings firsthand, we must rely upon their periodic pronouncements, which are invariably trimmed to suit whatever point the central bankers want to convey. Another case in point is the statement released by the Federal Reserve’s FOMC this past Wednesday after its meeting behind closed doors.

Of significance is the change in wording from the previous month. I am hard pressed to see a difference, but Fed watchers who interpret every nuance of an FOMC statement were quick to tell us what it meant. To their eagle-eyes a few words can make a big difference. In this case, they believe that the Fed was signaling that there would not be any hike in interest rates for the foreseeable future.

They reached this conclusion because the FOMC statement said that the “adjustment in the housing sector is ongoing”. This simple statement contrasts with what the FOMC had said after its meeting only a month before: “some tentative signs of stabilization have appeared in the housing market.” In other words, the Fed recognizes that the economy is already fragile because of the popping of the house-price bubble. So to avoid making a recession even more likely, the Fed will not raise interest rates.

Of interest though is the rest of the FOMC’s statement, and specifically the comments that address the rising inflation we see all around us and experience everyday. The statement notes that the FOMC’s “predominant policy concern remains the risk that inflation will fail to moderate as expected”. But how is inflation going “to moderate” if the Fed is not going to raise interest rates?

Raising interest rates is essentially the Fed’s only tool to fight inflation. Higher rates make the dollar more appealing, therefore increasing demand. Also, higher rates make borrowing dollars more expensive and therefore less attractive, which as a consequence decreases the supply of dollars.

An increase in the demand and drop in the supply of any good will make that good more valuable. This basic economic principal also applies to money. Therefore, rising interest rates will make the dollar more valuable, or to put it another way, strengthen its purchasing power. A stronger purchasing power means less inflation.

So there is clearly an irreconcilable incongruity in the FOMC’s statement. We are told that inflation remains the FOMC’s predominant “concern”, but also that it will not be raising interest rates anytime soon. However, if the Fed is not going to raise interest rates, then inflation will continue to worsen.

What is clear is that the Fed is more worried about the possibility of a recession than maintaining the value of the dollar. It will therefore attempt to jawbone a solution. To do so, the Fed – like other central bankers – will talk out of both sides of their mouth. The Fed will tell us that it is concerned about inflation, but by not raising interest rates, it won’t do anything to stop the worsening inflation we are now experiencing.

Regardless of the double-talk from the Fed, one thing is certain. The bullish outlook for gold could not be clearer because dollar inflation will continue to worsen.