The Federal Reserve got by for nearly 95 years by monopolizing the ability to provide something for nothing, something that appealed to governments, companies, and consumers alike. They substituted debt for money, and in the process opened up a world of possibilities never before fathomed.
The plan went well, people began to circulate the debt in place of money, with those closest to the Fed paying the least and those furthest way paying more, and people toiled day in and day out to move further up the food chain.
Sure, using debt as money left the occasional sinkhole in the economy, on those rare occasions when more debts were being cancelled than issued, but the Fed simply lowered interest rates to provide adequate incentive for people to demand more debt, lowering the perceived price of getting something for nothing.
Now, circa 2014, the Fed has lowered interest rates to zero and has taken the extra step of creating even more debt of its own to circulate. While things should be going gangbusters at the Fed factory, we open the pages of the financial news to find that:
a) The Fed can no longer control the interest rate mechanism as it did before and;
b) The Repo market, which funds $1.6 trillion in short term loans every business day, is going no bid on an increasingly regular basis thanks to the 2010 Dodd-Frank Act, which was supposed to fix these sort of problems.
The Federal Reserve's debt based monetary system has reached its theoretical limit. While the ECB has toyed with the idea of negative interest rates, the US market, specifically US Treasuries which are sucked into the Repo Market nightly, is rendering negative rates on its own, and the Fed is powerless to stop it.
In layman's terms, the game has flipped on the Fed, and now people and companies are essentially saying that $100 today is worth $98 in a year. Crazy as it may sound, this is the reality on the fringe of the credit markets, and it is the price of continuing to deal in a debt-based currency.
Between shenanigans such as Quantitative easing, Operation twist, and near zero short term rate targeting, Ben Bernanke has so severely mangled the Fed's balance sheet with his tinkering that maintaining the integrity of the US dollar and US Treasuries through conventional means is all but impossible.
Now, the engine of the Fed's debt based currency is beginning to lose speed via negative nominal rates, and Janet Yellen is looking into the toolbox, only to realize that Ben left most of the tools rigged in the engine of the Fed's Balance sheet, and that moving any one of them will cause a catastrophic failure of the currency. Not to mention that long awaited, highly inflationary wage - price spiral is about to kick in.
Academic economists will one day struggle to explain what is happening now, while inflation rises, interest rates continue to dip further, going negative at the top of the financial food chain, and the Fed is left with nothing but rhetoric with which to attempt to execute monetary policy.
The ride is likely to be rocky and the headlines are likely to get even more bizarre as the Fed goes headlong into the next crisis without a clue as to what is occurring, nor the tools it would need to solve it.