Federal Reserve minutes warn US economy won't recover for 5 more years

Here's one of these little tidbits that most Americans don't read in an American newspaper, or hear being uttered from our President's (or any banker's) mouth on Sunday Morning talk shows.

The Fed minutes warned of "significant downside risks" and a possible slide into deflation, an admission that zero interest rates, $1.75 trillion of QE, and a fiscal deficit above 10pc of GDP have so far failed to lift the economy out of a structural slump.

"The Committee would need to consider whether further policy stimulus might become appropriate if the outlook were to worsen appreciably," it said. The economy might not regain its "longer-run path" until 2016.

"The Fed is throwing in the towel," said Gabriel Stein, of Lombard Street Research. "They are preparing to start QE again. This was predictable because the M3 broad money supply has been contracting for months."

Fed admits economy likely won't recover until 2016

Regular readers of this blog will recall that I posted a chart on M3 money supply declining at a rate not seen since the Great Depression. They would have been forewarned that this is a clear sign of de-leveraging, including folks getting "debt free" and others defaulting on their credit cards and mortgages.

I posted the following link on June 1st, 2010:

M3 collapsing at 1930's rate

We must all recall that debt equates to money supply. The money we deposit into our banks accounts are actually loans to that bank. They turn around and re-lend it to other borrowers at a 9:1 ratio. Simplistically stated, they loan out up to $9 for every $1 in deposits, betting that the majority of those extra loans will not default. So.. for every $1 in your account, $9 more dollars are added to the money supply.

However, when loans start defaulting, or consumer demand for borrowing diminishes (either due to lack of creditworthiness, or just lack of demand), those banks have to pay interest on deposits with less interest revenue from the remaining loans they have extended. And when loans default, they have to write them off and pay out from remaining interest revenue.

All of this results in the destruction of money supply, and usually price deflation due to ebbing consumer demand. Additionally, there is a "velocity" of monetary transactions factor that is often not considered. It's determined by the number of times a $1 exchanges hands in a business transaction. The slower the velocity of transactions, the lower goes the Gross Domestic Product of the Economy. People saving too much out of fear of, or expectation of future declining prices decreases our GDP. Banks worried that collateral will depreciate below loan value will either require more collateral, or refuse to loan.

Think of the economy and money supply as a wind sock that has to have a constant flow of air through to remain pointed in a horizontal direction. If the wind ebbs, the windsock will go limp..

That's why that Consumer Confidence Number is so danged important. If the consumer is not buying, they aren't taking out loans (decreasing money supply), or spending cash (decreasing velocity). Supply and demand dictate that both must remain in balance. Reduce demand and excess will need to be liquidated at discount prices. The TRUE problem will be when supply is reduced and pent up consumer demand then creates inflationary pressures.

But for now, we're looking at deflationary pressures as the primary threat. Deflation is FAR MORE DIFFICULT TO RESOLVE than inflation is. It's easier to reduce demand by raising rates than it is to increase demand from masses of unemployed and fearful people who've suddenly rediscovered the merits of frugality and living debt free.

I am currently debt free with $$$$ in the bank and my brokerage account.. Are you?

Scrutinizer