The best, short, laymen’s description of our current economic situation

by Bill Hall,

Central bankers’ actions are destroying savers who rely on interest payments from their bonds.

In last week’s Money and Markets column, I explained that the Federal Reserve’s policy of keeping interest rates low and purchasing trillions of dollars in securities is pushing investors further into the danger zone.

This unconventional approach is good for big banks, governments and borrowers (after all, who doesn’t like to borrow money for free?), but it is very bad for savers.

Near-zero interest rates have created incentives for the world’s biggest banks to borrow from the Fed — as well as the developed world’s other central banks — and allocate the money to their proprietary trading desks to engage in risky leveraged financial-market speculation which, in turn, artificially props up the stock market.

On the other hand, near-zero interest rates punish prudent savers who are called upon to bail out the reckless. Everyone who thought their savings might provide a comfortable retirement has to come up with another plan with interest rates near zero.

In the uniquely unusual world in which we live, the Fed and other central banks have created a scheme designed to encourage consumers to spend to help the economy while taking money away from savers who would like to earn a respectable rate of interest. But, ironically, the very same policies that are intended to induce savers to consume more actually causes them to spend less in order to make their savings last.

We live in an upside-down world where the actions of central banks are destroying savers who rely on interest payments and fixed coupons from their bonds. They also harm lenders who have lent money and will be repaid in devalued dollars, if they are repaid at all.

Today is a time of financial repression, where central banks keep interest rates below inflation. Standards of living are falling for many, economic growth is anemic, big banks are bailed out and older savers are punished.

Why is this going on?

Federal Reserve Chairman Ben Bernanke is one of the world’s experts on the Great Depression. He has learned from history and knows that too much debt can be lethal. He also knows that the world’s financial system is loaded with debt that it can’t repay.

Debt can only be retired in three ways: 1. defaults; 2. paying down debt through economic growth; or 3. eroding the burden of debt through inflation or devaluations. During the Great Depression, we had defaults. But defaults are painful, and no one wants them. We don’t like pain.

Growing our way out of our debt problems would be ideal, but it isn’t an option.

That means Bernanke is left with no other option but to print and devalue the dollar because he promised he would not let deflation and another Great Depression grip America.

In the movie A Few Good Men, Jack Nicholson played Colonel Nathan Jessup, who was guilty of using unconventional approaches to discipline to preserve America’s freedom.

The endgame for the central banks is not difficult to foresee; in fact, it’s already under way. The difficulty lies in trying to predict “when” these policies will unravel.

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