Lending Money Below the Inflation Rate

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It is May Day in Europe. It is a holiday for almost everyone. But here at The Daily Reckoning ‘s mobile headquarters, we keep reckoning day in and day out.

And what we reckon today is that two extraordinary things happened yesterday – related to one another and equally absurd.

Yesterday, the Fed did what it was widely expected to do – it lowered rates by 25 bps, bringing the key Fed lending rate down to 2%, or about half the rate of consumer price inflation. And that is where we begin to wonder. What kind of a bank would lend money for less than the inflation rate? Isn’t it sure to lose money?

Yes, of course…but it’s a long, long story…

The other extraordinary thing that happened was that the U.S. federal government began sending people “tax rebates.” Of course, they are not tax rebates at all. Everyone who filed a tax return will get $300, whether he owed any taxes or not. A taxpayer will get another $300. Plus, children and dependents will get $300 each.

Alas, today’s news tells us that much of the presumed benefit from the giveaway program will be lost because of higher fuel and food prices.

(And here we offer some helpful advice: We’ve heard that SUVs aren’t selling very well anymore. Maybe the feds should give every family an SUV – one made in America, of course. That would be good for the auto industry – and then people could take the money they save from not having to buy a new car themselves and use it to buy gasoline and groceries.)

The U.S. government is already $9.3 trillion in debt (not to mention the other $40 trillion ‘financing gap’). It is giving out money it doesn’t really have – $106 billion worth. But it is doing so for good reason – or so it believes. The president of all the Americans – George W. Bush – said that the handouts will be “good for the consumer economy.”

Lending money below the inflation rate…giving out money you don’t have, when you are already so deep in debt you will never get out – how could any of this be good for the real economy? But by this time we are so far into Never-Never Land that we will never find our way back.

A consumer economy may benefit from consumer spending – but only if consumers have money to spend. If giving away phony money, which you don’t really have, could make things better – why stop at $300 a head? Why not give away $1,000 a person…or $5,000?

Likewise, if it’s a good idea to lend money at 2% below the inflation rate…why not lend it at 10% below the inflation rate?

The really extraordinary thing is that the brightest minds in the nation think they can control the economy in these extraordinary ways. But they would think so, wouldn’t they? The guy who believes drinking doesn’t affect his driving is always the guy with the whiskey bottle.

Meanwhile, there was some ordinary news yesterday too. The Dow eased off 11 points. The euro stayed at $1.55. And gold lost another $11 – dropping to $866. Wouldn’t it be nice if the price would fall below $800! Maybe it will; maybe it won’t. But Dear Readers are urged not to lose heart. This bull market in gold isn’t over yet. The real excitement is still ahead.

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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Comments

  1. Interesting, if not totally insightful. The reason the US Fed government can loan below inflation rates (which are lies) is that the creditor is receiving something in addition to the interest yield. He is getting some security of the return of his money, but foregoing a return on his money. Things must be worse than they appear, if that is possible. Remember controlling printing presses does matter, even to people as smart as Bill Bonner.

    As for debt levels of various world states, the USA is disgustingly high, but it is not alone in offical profigatacy. In fact, most of the westernize societies have like problems. Why is that? Could it be that trading and currency adjustments are not well aligned? Over consumption should have been impossible, but it was not; the US currency unit remained strong long after it was seen to be declasse’. Why? That question leads to the greater fool theory among producing and consuming countries. Oh well you get the point, or should anyway.

    jack Bonner
    May 6, 2008
    Reply

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