Clouds hovered in the skies over the Eccles Building in Washington, D.C. this week as the Federal Open Market Committee (FOMC) held its final meeting of the year.
Inside the climate-controlled building an unelected body of statist central planners supped mugs of coffee brewed with beans imported from the southern hemisphere. They also applied consensus and conjecture to fix the price of credit.
The big idea is that the Federal Reserve can moderate the business cycle by dictating the supply of money and credit. The Fed’s track record over roughly 110 years tells a contrary story of persistent inflation and the advancement of bubble finance.
What is especially important to understand about the Fed is that, through its twelve regional Federal Reserve Banks, it serves the interests of privately-owned commercial banks. All efforts to enhance the economy are secondary.
Understanding this generally unspoken objective of the Fed is crucial to making sense of what the Fed says and what it does. In particular, the Fed’s words and actions don’t always line up.
This week, for example, in the face of a recent CPI report that shows consumer prices are inflating at an annual rate of 2.7 percent, which is well above the Fed’s arbitrary 2 percent target, the Fed opted to cut interest rates by 25 basis points. This brings total rate cuts thus far in the current rate cutting cycle to 100 basis points.
In Fed Chair Jerome Powell’s own words, “Today was a closer call but we decided it was the right call.”
Why is the Fed cutting interest rates when the CPI is still running hot? Do big banks like Bank of America need cheaper credit to bail out their holdings of underwater debt securities?
Market intervention always comes with consequences. Food shortages. Consumer price inflation. Scarcity of toilet seats. Supply dearths and gluts. Pretend jobs. Administrative insanity. Bubbles and busts.
Cheap credit may have a stimulative influence on an economy with moderate debt levels. But once an economy has reached total debt saturation, where new debt fails to produce new growth, the cheap credit trick no longer works to stimulate the economy. In fact, the additional credit, and its flipside debt, distorts prices and strangles future growth.
The current financial and economic paradigm, characterized by heavy handed fiscal and monetary intervention and extreme debt levels, is an epic problem. Debt based stimulus is both sustaining and killing the economy at the same time.
This ridiculous situation is the sort of thing that can only be fabricated by the foolish hands of central planners. Here, for fun and for free, we’ll look to California’s San Joaquin Valley for edification…
The World’s Richest Agricultural Valley
Dropping down the backside of the grapevine from the Tejon Pass, along Interstate 5 between Los Angeles and San Francisco, one is greeted by an endless sea of agricultural fields.
These farms of the mega San Joaquin Valley are not the 160-acre family homestead farms rooted in the 19th century settlement of the Midwest. Nor are they in the yeoman farmer tradition envisioned by Thomas Jefferson. They are large-scale, highly productive, corporate farms.
These massive agricultural operations, if you’ve never seen them, are quite a sight. But what’s more incredible is that they even exist at all. The dry conditions of the area make it a miracle that anything – aside from cactus and scrub – can grow here.
The late James Parson, a long-time professor emeritus at the University of California Berkeley, once provided these observations:
“The southern part of the valley was a barren desert waste with scattered saltbush when first viewed by Don Pedro Fages in 1772 coming from the south over Tejon Pass. Less than five inches of rain annually falls in southwestern Kern County, maybe ten inches at Fresno. Pan evaporation in a summer month on the west side pushes 20 inches.”
Still, the barren desert wasteland and parched conditions observed by Fages some 250 years ago, including a negative water cycle, didn’t stand in the way of what was to come.
With an outsized imagination, several mega water diversion projects, federal and state subsidized water, and cheap migrant field workers, mankind was able to create what “has been called ‘the world’s richest agricultural valley,’ a technological miracle of productivity.”
However, the endless dumping chemical fertilizers, pesticides and herbicides, and imported water on sandy soil underlain by indurated hardpan is not without consequences.
What has stimulated the productive miracle of the San Joaquin Valley over the last century is the same blend of factors that has propped up America’s financial markets and blown out government debt loads over this same period. Cheap credit and excess liquidity.
Seeds of Disintegration
In his magnum opus, Cadillac Desert, which documents the insanity of water resource development in the west up through most of the 20th century, the late doom aficionado Marc Reisner offers the following characterization:
“Like so many great and extravagant achievements, from the fountains of Rome to the federal deficit, the immense national dam-construction program that allowed civilization to flourish in the deserts of the West contains the seeds of disintegration; it is the old saw about an empire’s rising higher and higher and having farther and farther to fall.
“Without the federal government there would have been no Central Valley Project, and without that project California would never have amassed the wealth and creditworthiness to build its own State Water Project, which loosed a huge expansion of farming and urban development on the false promise of water that may never arrive.”
In the San Joaquin Valley, vast irrigation networks convey water thousands of miles to make the desert bloom. As this surface water is conveyed along the dry climate of the California aqueduct, it both evaporates and collects mineral deposits.
The combination of these factors concentrates the water’s salt content. Then, as it’s applied for irrigation, the residual salts collect in the soil.
After decades of this, along with the over application of fertilizer through mechanized fertigation systems, the salt in the soil has built up so that it strangles the roots of the plants. To combat this, over-watering is required.
By this, the irrigation water – while salty – is fresher than the salt encrusted soil. Through the application of excess irrigation water, the soils around the plants are temporarily freshened up so that crops can grow. At the same time, this over-watering accelerates the mass quantity of salt being applied to the soil.
How the Fed Chokes the Economy
There’s no outlet in the San Joaquin Valley for the salt to flush. The valley is the basin’s terminus. Thus, in this grand paradox, the relative freshness of the excess water that is keeping the farmland alive is, at the same time, the source of the salt that is killing it.
Reisner further explains:
“Nowhere is the salinity problem more serious than in the San Joaquin Valley of California, the most productive farming region in the entire world. There you have a shallow impermeable clay layer, the residual bottom of an ancient sea, underlying a million or so acres of fabulously profitable land.
“During the irrigation season, temperatures in the valley fluctuate between 90 and 110 degrees; the good water evaporates as if the sky were a sponge, the junk water goes down, and the problem gets worse and worse. Very little of the water seeps through the Corcoran Clay, so it rises back up to the root zones—in places, the clay is only a few feet down—water logs the land, and kills the crops.”
So, too, goes the U.S. economy. After nearly two decades of rapid balance sheet expansion and pumping cheap credit and excess liquidity into financial markets, the Fed has produced a similar paradox. It must keep supplying more and more debt-based currency to keep the economy afloat…but in doing so, it’s ultimately killing it.
Certainly, the Fed knows it cannot expand its balance sheet without periodic, and abrupt, reductions. These are needed to whipsaw overextended debtors and attain some semblance of connection between the economy and financial markets.
What’s especially absurd about our present circumstances is that the Fed is reducing its balance sheet and cutting the federal funds rate at the same time. This is like applying water and salt to crops simultaneously. The Fed’s unstated purpose is to attain some headspace so it can later increase its balance sheet when the next big bank bailout is needed.
Regardless, there’s no way out for the Fed at this point. The present financial order, like the salty crop fields in the San Joaquin Valley, is doomed to choke on the salt of debt.
Perhaps several lifetimes – or more – of fallow conditions will restore economic growth and fertility to the country. But the ultimate demise of the San Joaquin Valley as an agricultural region will be indefinite.
[Editor’s note: Have you ever heard of Henry Ford’s dream city of the South? Chances are you haven’t. That’s why I’ve recently published an important special report called, “Utility Payment Wealth – Profit from Henry Ford’s Dream City Business Model.” If discovering how this little-known aspect of American history can make you rich is of interest to you, then I encourage you to pick up a copy. It will cost you less than a penny.]
Sincerely,
MN Gordon
for Economic Prism
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