Tuesday, June 15, 2010

Federal Reserve Very Concerned About Double Dip Recession

The Federal Reserve appears to have serious concerns that the economy is heading into a double dip recession. That's the only way to read a report coming from WSJ reporter Jon Hilsenrath.

Couched in the conservative, hedging style of the Federal Reserve, Hilsenrath's column is really a five alarm fire bell. Hilsenrath does not quote anyone by name and merely refers to "Fed officials", but this type of story does not come out without a strong source.

Hilsenrath writes:
Federal Reserve officials are beginning to debate quietly what steps they might take if the recovery surprisingly falters or if the inflation rate falls much more.

Fed officials, who meet next week to survey the state of the economy, believe a durable recovery is on track and their next move—though a ways off—will be to tighten credit, not ease it further. Fed Chairman Ben Bernanke has played down the risk of a double-dip recession and signaled guarded confidence in the recovery.

But fiscal woes in Europe, stock-market declines at home and stubbornly high U.S. unemployment have alerted some officials to risks that the economy could lose momentum and that inflation, already running below the Fed's informal target of 1.5% to 2%, could fall further, raising a risk of price deflation.

The Fed's official posture is unlikely to change when policymakers meet June 22 and 23: The U.S. central bank is expected to leave short-term interest rates near zero and signal no inclination to change that for a long time.

But behind-the-scenes discussions at the meeting could include precautionary talk about what happens if the economy doesn't perform as well as expected.
What is the Fed considering doing if it is clear the economy is headed for a double dip recession? Why, print more money, of course.

Hilsenrath writes:
...he recovery falters, or if inflation slows much further and a threat arises of deflation, a debilitating fall in prices across the economy. In such cases, there would be a few avenues the Fed could take.

One is asset purchases. During the financial crisis, the Fed purchased $1.25 trillion in mortgage-backed securities on top of buying debt issues by Fannie Mae, Freddie Mac and the U.S. Treasury. Mr. Bernanke has said the steps helped to lower long-term interest rates, including rates on mortgages.

The Fed could resume such purchases, although it isn't clear that they would have as powerful an effect as they had in 2008 and 2009, because long-term rates are already low. Rates on 30-year fixed-rate mortgages are about 4.7%, down from 5.2% in early April.

The Fed could also take an intermediate step. Right now, it isn't reinvesting cash it gets when mortgage-backed securities are paid off by borrowers. If the Fed reinvested that cash—projected to be about $200 billion through 2011—in mortgage bonds or Treasurys, it would help keep the financial system awash in money and could hold interest rates down.
These are all money printing means that will ultimately lead to inflation. It is, ultimately, the only tool the Fed has at its disposal and is a very good reason to own gold, even if there is the potential for a short-term dip in the price.