The Fed Statement: Economy Still Flatlining

The para­mount inno­va­tion in the Fed­eral Reserve’s state­ment yes­ter­day was that it will keep inter­est rates low until at least the mid­dle of 2013. The truth of the mat­ter is that our econ­omy is like a patient on the oper­at­ing table whose heart has stopped and the doc­tors are scram­bling to get it going again. And the Fed’s state­ment yes­ter­day reveals that the Fed rec­og­nizes the patient’s heart is still not beat­ing, and it's employ­ing no new mea­sures to try and get it beat­ing again.

Did any­one really expect the Fed to announce it would raise rates any­time in the near future? The state­ment con­firms my point in yesterday’s postthat the Fed is out of bul­lets. What else can it do to address our eco­nomic woes except keep rates low for even longer?

Also of inter­est is the market’s reac­tion to the Fed’s state­ment. How is the fact that the econ­omy is doing so poorly that we will need close to zero inter­est rates for another two years good news? Funny, I remem­ber the same pun­dits who cheered yesterday’s Fed state­ment say­ing ear­lier this year that they were bull­ish on stocks because they expected the Fed’s next move was likely to raise rates sooner than expected in response to the econ­omy doing bet­ter than expected. So, again, how is it good that rates will be kept lower for longer?

The best news out of the state­ment is that there is at least some dis­sen­sion. I am not sure on what side of the issues the dis­senters stand. How­ever, the dis­sen­sion gives me hope that there is at least some recog­ni­tion that keep­ing inter­est rates low under­mines the long-term eco­nomic growth poten­tial of our economy. The longer we allow cap­i­tal to flow to lower-return invest­ments, the less cap­i­tal is avail­able for higher returns invest­ments. Our eco­nomic growth is slower; there are fewer jobs; there is less demand/consumption; and there is less cap­i­tal to allo­cate to higher-return opportunities

It is clear that low rates for extended peri­ods of time are not a recipe for the long-term pros­per­ity of our economy. Low rates are like Key­ne­sian stim­u­lus: They can be effec­tive over short peri­ods of time but can do last­ing long-term dam­age if left in place too long. If Mr. Bernanke thinks he has no choice, then I sug­gest he take a look at the riots in the streets in Lon­don. He will see that our sit­u­a­tion can get much worse.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.