The Fed is becoming more concerned about the sustainability of the U.S. recovery, just as the economy looks to be gaining momentum. The unemployment rate has dropped from 9.4 percent in December of 2010, to 8.5 percent twelve months later. The American economy has added 1.5 million jobs over the past year, according to the establishment survey of employment, while the household survey shows we have averaged a monthly gain of 230,000 jobs over the past six months. Meanwhile, the average work week and hourly earnings also showed improvement in the December Nonfarm payroll report. In addition, Gross Domestic Product has increased for nine consecutive quarters and is anticipated to post just under a 3 percent annualized growth in Q4 2011, up from 1.8 percent during the prior quarter.
So what was the Fed's reaction to this ostensibly better news? San Francisco Fed president John Williams told the WSJ in an interview conducted after the December's NFP report release that the central bank will have to buy more mortgage related bonds and that interest rates would not increase for a very long time. Here is his quote: "Unemployment is going to be sustained above a reasonable estimate of the natural rate of unemployment, which is closer to 6.5 percent than the 8.5 percent that we have now. That does make an argument that we should have more stimulus."
William Dudley, president of the Federal Reserve Bank of New York, also detailed several proposals to revive the U.S. property market in a recent speech. His plans included a principal reduction for borrowers, eased refinancing terms for homeowners who owe more on their mortgage debt than their homes are worth, and a U.S. taxpayer-funded program to extend financing to unemployed borrowers. Mr. Dudley gave his reasoning for more central bank easing last Friday by saying, "The outlook for unemployment is unacceptably high relative to our dual mandate and the outlook for inflation is moderate." Sarah Bloom Raskin, a member of the Fed's board of governors, added this weekend that forcing major banks to cut mortgage principal as a penalty for poor practices was an option "that should stay on the table."
And now, as unbelievable as it sounds, the individuals who are supposedly responsible for preserving the value of our currency are close to adopting a specific inflation target for the rate of its depreciation. James Bullard, president of the Federal Reserve Bank of St. Louis, said late last week, "We are very close to having inflation targeting in the U.S." Why isn't it obvious to members of the FOMC that the target rate of inflation should be zero?
But there are many problems with having an explicit target for inflation -- one of those is which inflation metric will the Fed decide to use. The most likely measurement of prices the Fed would utilize is the core rate of the Personal Consumption Expenditure Price Index (PCEPI). But this measurement not only excludes energy and food price increases but it has also, historically speaking, produced much lower inflation numbers than the Consumer Price Index (CPI). For example, the PCEPI for the third quarter of 2011 increased at an annual rate of 2.3 percent and the core rate increased slightly less at 2.1 percent. However, the CPI increased at an annual rate of 3.1 percent during the same time period. In fact, headline PCEPI has historically run about one-third less than overall CPI.
What's even worse is the Fed uses the core rate of PCE, which is a chained weighted index that excludes the things that Americans need to survive on a daily basis. Therefore, the real rate of inflation suffered by most Americans will be significantly higher than the rate the Fed is targeting. The reality is that the Fed is now stepping up their easy-money rhetoric, despite the fact that they have conducted a more than four year campaign to produce a higher rate of inflation and lower the value of the dollar.
Both the Fed and markets (the yield on the Ten Year note is under 2 percent) have dismissed this recovery and for good reasons. Bernanke's Fed has decided to ignore the better economic news and to continue its assault on our currency, the middle class, savers and those living on a fixed income. He understands that the European debt crisis is one that rhymes with the credit crisis of 2008, and will dramatically lower the rate of GDP growth in the U.S. during 2012. But the more important reason is that the U.S. has now accumulated more debt than our tax base can support.
Our debt now exceeds the total of our GDP and the annual deficits pile on an additional $1.3 trillion each year to that accumulated debt. Our publicly traded debt has increased 100 percent in the last five years alone! What is even worse is that our debt as a percentage of revenue is exploding. Back in 1971, the national debt was 218 percent of revenue. Back in the year 2000, that debt as a percentage of revenue had grown to 280 percent. Today, it has skyrocketed to 700 percent of revenue. Our government simply cannot survive having that much debt in relation to revenue.
The worst is yet to come because interest rates are now at an all-time record low. The average yield on U.S. debt is near 1 percent today, but it was 6.5 percent in the year 2000. And given our record level of debt and Fed-led money creation, yields on Treasuries could and should go much higher than at any other point in U.S. history. How easily can the U.S. service our $15 trillion -- and rapidly growing -- national debt if interest rates rise just a few 100 basis points? Only imagine what would happen if they rose to where yields on Italian or even Greek debt is today.
That's why the Fed can't raise the overnight lending rate between banks. And they will fight with everything they've got not to allow market-based interest rates to rise on the long end of the curve either. Therefore, our central bank deems it necessary to encourage an onerous level of inflation to exist in the economy in an effort to grow nominal GDP and increase tax revenue. Of course, their strategy is doomed to fail like every other attempt at inflating the problem of too little revenue away. That's because a central bank cannot control long term interest rates forever. American citizens can only hope Bernanke's Fed learns that lesson before our foreign creditors view U.S. debt in the same light as Greece.
Michael Pento is the President of Pento Portfolio Strategies.