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FISCAL ANALYSIS:

Thinking about Dilemmas

by FRED CEDERHOLM
The short-term “solution” to forestalling a post-9/11, post-dot.com bubble—by dropping the Fed rate to just 1%—has now given rise to a bigger long-term “dilemma.”
I’ve been thinking about dilemmas. Actually I’ve been thinking about the Fed’s Open Market Committee (FOMC), Bernanke, inflation/deflation, debt, global cash dependency, and US/us. There is a time value for money, and that is called interest. If you accumulated money by spending less than you’ve earned (or taken in), “interest” means extra income to you. If you owe money because you’ve spent more than you’ve taken in, “interest” is an expense. You see, the Open Market Committee of Uncle $ugar’s central bank, the Federal Reserve, met this past Wednesday and Thursday to re-evaluate/set the benchmark rate of interest that will ripple to all the interest rates paid (and charged) in the United States. As expected, there was another increase—another quarter of a percent, marking the 17th consecutive increase since the Fed Fund’s rate bottomed out at 1.00% on June 25, 2003.

This was the third session since Ben Bernanke replaced Alan Greenspan as the Chairman of the Federal Reserve on January 31, 2006. Controlling the level of inflation is a major priority for him (and for the Board of Governors of the Fed). This means we could see yet more interest rate increases in the near term. We also know from Bernanke’s earlier writings and speeches that he greatly fears deflation—the situation where the price of goods/services drops because consumers are not buying. They just do not have the funds, and they cannot get them. Rate setting is very important to the functioning of the American/global economy.

To forestall a recession some five years ago in the aftermath of 9-11 and the bursting of the dot-com stock bubble, the economy was flooded with liquidity, the Fed’s rates dropped to 1%, and they languished there for years. Cheap money did keep our economy "rolling,” and a recession was deferred. The expanded consumption of goods and services that ensued was not driven by a growth in production, productivity, or a real expansion of the domestic American economy; it came from an exponential growth of debt at the federal, state, local, and household level(s). The short-term “solution” has now given rise to a bigger long-term “dilemma.”

Cheap money may have postponed one recession, but a "T-Rex” of a housing/real estate financing bubble has replaced “the tiger” of the dot-com bubble.
While a very few households have profited exceedingly well from this so-called (debt-driven) “prosperity,” some households have merely treaded water—and the majority of them have dug themselves into a deeper abyss of debt. To supplement stagnant (or declining) incomes while maintaining/increasing lifestyles and consumption, “equity” loans have made the family home a veritable cash station. Cheap money may have postponed one recession, but a "T-Rex” of a housing/real estate financing bubble has replaced “the tiger” of the dot-com bubble.

America’s growing debt was not financed from within. Cumulative domestic saving has been at zero—or has been negative. The US is presently “thriving” only because of the largesse of foreigners. The Japanese, the Chinese, the Arab OPECs and the EURO zone hold roughly 45% of our outstanding privately held (national) debt. As of June 22, our national debt stood at a record $8.340 TRILLION of which $4.787 TRILLION was privately held, and the remaining $3.553 TRILLION was the cumulative trust fund surpluses (mostly Social Security) that have been raided/spent by Uncle $ugar on everything but their legally mandated purposes.

As of April 30 (reported by the US Treasury/Federal Reserve Board on June 15, 2006), the top ten foreign holders of treasury securities were as follows: Japan $ 639.2 BILLION, China $323.2 BILLION, United Kingdom $166.8 BILLION, Oil Exporters $99.1 BILLION, Korea $70.9 BILLION, Taiwan $68.9 BILLION, Caribbean Banking Centers $61.0 BILLION, Hong Kong $ 49.4 BILLION, Germany 46.8 BILLION, and Mexico $41.9 BILLION.

Since the last FOMC meeting, other central banks across the globe have raised their own benchmark rates. While Wall Street and Main Street clearly oppose any further rate increases—because of the devastating impact on their monthly interest costs—the Fed/Treasury cannot afford any exodus of the foreign source funds. That money has to stay invested here, and therein is another dilemma.

I’m Fred Cederholm and I’ve been thinking. You should be thinking, too.
Copyright 2006 Questions, Inc. All rights reserved. Fred Cederholm is a CPA/CFE, a forensic accountant, and writer. He is a graduate of the University of Illinois (B.A., M.A. and M.A.S.). He can be reached at asklet@rochelle.net.

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This story was published on June 30, 2006.