The Federal Reserve's Zombie Economy Deutsche Bank is out with a new warning that says the Federal Reserve's latest round of an estimated $1.02 trillion in total annual purchases of U.S. Treasuries and mortgage-backed securities is creating lemon socialism, a U.S. economy filled with the financially undead. Deutsche notes that stock markets are based on winners and losers, but there are neither right now. That's because the Fed keeps pumping liquidity into the system, so everyone wins. When everyone wins, no one makes money, a bridge to nowhere Japan has already crossed. The Fed's balance sheet could rise from $2.8 trillion currently to $4 trillion by the end of the year, even $6 trillion by the time the U.S. jobless rate gets down to the new 6.5% level the central bank wants, as the Fed stuffs a lot of paper padding at the foot of the fiscal cliff. "Central banks should be more selective with their intervention," says Deutsche's equity research team. Normally, weak companies fail, leaving the winners to advance and new companies to enter; but at the moment no company can win because the losers never leave the field as they receive support through continuous liquidity injections. Deutsche's equity team adds if the Fed were to "let markets decide, then equity markets would probably fall." It also notes: "But, as it is, if real investors can't predict which way markets will go, then they will stay on the sidelines." Deutsche also says that all of this government help essentially turns into government resentment, and it turns profits--or your wallets--into sitting ducks, a bulls-eye painted on them. "Capital is rewarded through profits, but currently high profits can either appear socially unacceptable or as easy targets for taxation," Deutsche says. Consumers will pay dearly for the Fed's new 6.5% jobless rate as cash gets trashed, a jobless rate paid for with the Fed's new inflation target of 2.5%, higher than the Fed's previous 2% target rate. "The Fed continues to operate an open bar for the fiscal drunks in Washington," says economist Ed Yardeni. This is the heavy flip side to all the cheering about Fed intervention and the federal government's AWOL "balanced" approach to the budget. The end game: Fix a U.S. jobs crisis borne out of a debt crisis. Avoid social unrest and protectionism. Drive down borrowing costs by buying U.S. Treasuries, with the central bank now buying two-thirds of the U.S. Treasury's annual output. Get long-term mortgage rates down to 3% to lift homes out of negative equity. Give bailouts to zombie companies and zombie consumers to start spending money again by making money really cheap. The financially undead who can only just barely pay their fixed operating expenses and interest costs only on their debts (and not reduce principal). Also, let the U.S. government avoid tough fiscal decisions so political cronies can get re-elected by spending whatever they want on "stimulus," with the Federal Reserve only charging the federal government a quarter of a percentage point in interest for its massive Treasury purchases. Don't ever raise rates, you'll rock the Treasury and muni bond markets and not flush out rotten politicians who don't know what they're doing with your tax dollars. But stimulus isn't a magic lever in an economy where domestic demand is still sluggish, and where debt burdens are high. Creating more money doesn't magically create credit-worthy borrowers nor induce banks to lend to borrowers who still are not credit-worthy. Instead, the result is this: Lemon socialism, a term coined in 1974 by New York Democrat politician Mark Green to describe the chronically dysfunctional utility Con Ed, running with a tin cup even back then to the government. A field of dreams economy run by the U.S government, a "you didn't build that, we built it" economy, a build-it-and-growth-will-come field of dreams, President Barack Obama believes. But growth hasn't come. Instead, we have zombie companies and zombie banks and zombie government balance sheets in a zombie-land economy growing at just around 1.5% annually. Look at the zombie resurrection of GM (GM), Citigroup (C), Fannie Mae, Freddie Mac, and AIG (AIG), the still-dead insurer just barely walking. Look at the federal government's zombie balance sheet. A big stake in GM that's still underwater; bad student loans that will never be repaid; green energy assets on the government's dialysis machine, including solar energy and wind farms; empty federal buildings littering the landscape; loans to zombies Amtrak and the U.S. Postal service, and much more. The Federal Reserve's hundreds of billions in mortgage-backed debt rotted through with delinquent payments. The Federal Reserve and the U.S. Treasury have kept afloat "zombie" companies at a very high cost to U.S. taxpayers and consumers, not just due to coming inflation. Industry sectors are overloaded with too many companies, impeding profitability, aggravating the moral hazard of the government picking winners and losers, giving them unfair market advantages. Crony capitalism is remaking American business to be more like government. Who said that? The much-maligned Koch brothers. But it's a point that should be taken, and it's not. The Federal Reserve has been keeping zombie banks alive, too, in order to help banks continue to buy U.S. Treasury debt. If the U.S. government broke up big banks, those bank assets would end up on the Federal Reserve balance sheet, is likely the fear, as recent history shows with Bear Stearns, AIG and Lehman Brothers. So, let those assets sit moldering out there. Even though there are plenty of banks overseas who would buy them. Look at the U.K., where an estimated one in 10 businesses are really zombies and now stalk the British economy, resuscitated with central bank help (for more, see here.) Ernst & Young's U.K. division has already warned zombie companies in Britain are grabbing market share from healthy companies that now can't grow because of the detritus. "The whole thing grinds along very slowly," an executive at E&Y has warned, adding, "capital is not being recycled and reinvested as it should be." Japan has already impeded the "creative destruction" process Joseph Schumpeter warned is necessary in any healthy economy. Japan enjoyed a robust period from around 1954 to 1972, where GDP growth averaged 9.7% annually, akin to China's breakneck growth of more than 10% annually in the mid-"90s up until late last decade (a country also now loaded with zombie banks and companies). Japan continued along through the eighties, until late in that decade Japan went hog wild buying all sorts of property and bad assets. That bubble burst, and for nearly three decades now Japan has been in a juggling act trying to keep afloat zombie companies while still fixing bad balance sheets. To do that, Japan has created a big mountain of government debt to reflate its economy. That failed. Japan's politicians now stare morosely at this debt, while accepting slower economic growth on the order of 1.5% to 2%, similar to what the Federal Reserve predicts for the U.S., 1.7% to 1.8% growth. Meanwhile, despite all this liquidity, Japan's savings rate is lower than the rate in the U.S. because, you got it, spending is the end game. "Central banks cannot solve structural problems in the economy," Stephen Cecchetti, head of the monetary department at the Bank for International Settlements, tells The Wall Street Journal. We've been saying this for years, and it's getting tiresome. Or, as Stephen Roach of Morgan Stanley has said: "Washington policymakers are doing everything they can to forestall rational economic adjustments."