US Economy Will Mirror Japan Until Federal Reserve Raises Interest Rates

Once again, Ben Bernanke and his Federal Reserve cohorts have shown that they have no idea what they are doing. On August 9, 2011, the Federal Reserve released a statement saying they will keep the target fed funds rate between 0 to .25 percent through mid-2013. That is, the Federal Reserve is basically promising not to raise interest rates for two more years.

With that release, the Federal Reserve is dooming the US economy to the same scenario the Japanese economy has suffered under for the last two decades, for at least another two years. What does that mean? Slow to no growth, with, at best, modest gains in employment. A double-dip recession? The Federal Reserve just raised the odds of that happening significantly.

By keeping interest rates at artificially record low levels, the Federal Reserve will prevent the money supply in the United States from growing at all on its own for at least another two years. This is exactly the problem that they have had in Japan for well over two decades now.

Record low interest rates in Japan have prevented the Japanese money supply from growing on its own since the late 1980s. Whatever the Japanese economy has done since that time is pretty much what we can expect the US economy to do for the next two years.

Without money supply growth, an economy cannot grow because money in such an economy will remain too valuable for people living in that economy to spend or borrow it at levels sufficient enough to cause rapid economic growth, and subsequently low unemployment. A money supply grows on its own mainly through interest that lenders receive from borrowers.

If you have $1,000 in the bank earning 2% interest, at the end of the year you will have $1,020, and the money supply has grown. With record artificially low interest rates, you might earn .25% on your money, and at the end of a year you will have $1,002.50. That is not enough interest to make a money supply grow, because you also have to deduct money lost from an economy each year from failed businesses and such.

The sad part about the statement is that it shows that Ben Bernanke and the Federal Reserve FOMC members have learned nothing from Japan. They are doing exactly what Japan did. Lowering interest rates to record artificially low levels did not bring back Japanese economic growth. Japan was just passed by China this year as the world's second largest economy. Thanks to Bernanke and company, the Big Red Train that is China will have at least two more years to rapidly gain on our own economy.

Somehow, Ben Bernanke thinks that following the same failed policy he has steered the US economy with over the last two years, lowering interest rates to record artificially low levels, will magically work over the next two years. It will not.

(About 14 years ago I wrote a letter to an economist suggesting a scenario where you could see a negative interest rate. In theory, if money itself gained in value in a large manner, then a lender could loan their money out to a borrower with terms that the borrower pay back less money then he or she borrowed. The appreciation occurring in money could still ensure that the lender gets a return for lending the money, even though he or she is being paid back with less actual money, if the appreciation in the money is high enough.

In reality, the scenario would never happen as the lender would just keep all his or her money, and keep all the appreciation occurring in his or her money. To a lesser extent, this is why the banks are reluctant to loan money today. When someone like Ben Bernanke is in charge of the Federal Reserve, scenarios like this one get a chance to become as close to reality as possible, and that is not a good thing.)

Now, the Federal Reserve itself has the power to increase the money supply by buying assets in the economy with printed money. When the Federal Reserve does that, like with QE1 and QE2, the economy will grow. But as soon as the Federal Reserve stops those purchases, the money supply will stop growing because of the artificially record low interest rates.

The Federal Reserve has created a self-enforcing scenario. As long as economic growth remains low, they will keep interest rates at record artificially low levels. But the record artificially low interest rates are exactly what is keeping economic growth down.

Hello slow growth Japan, we are coming to join you for at least the next two years.

For more and background see How the Federal Reserve Can Fix the US Economy

Real Questions for the Federal Reserve

Why Congress Created the Federal Reserve

How the Federal Reserve Caused the Great Depression

How the Federal Reserve Caused WW II

Why People are Not Spending Their Money in the US Economy

Why Consumer Credit and Credit Card Debt Keeps Dropping in the United States

Are We Headed for Deflation?

Low Interest Rates Cause Low Economic Growth