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Wednesday, September 19, 2007

The First Suicidal Cuts

Pop went all my stops. Well, turns out all that talk about ‘no bailouts’ and ‘the dangers of moral hazard’ were just that: TALK. Bernanke did not learn from Greenspan’s mistakes.

I can’t stress this enough: The consequences of these actions in the long run are going to be SEVERE. The medicine is ALL wrong. Loose monetary policy caused this problem in the first place. Loose monetary policy can’t be the cure.

Although short term interest rates fell as a result of the rate cut the curve steepened as long term rates actually increased. The Bond market can already taste a jump in future inflation…

Most mortgages are priced based on the long-term rates. So, after the rate cut, things are looking WORSE for mortgage rates.

With these actions, I have lost a most of my respect for Bernanke and the Fed.

Fed Lowers Rate to 4.75 Percent, First Cut Since 2003 (Update6): “The Federal Reserve lowered its benchmark interest rate by a half point to 4.75 percent, the first cut in four years, to protect the U.S. from sinking into a recession sparked by fallout from the housing-market collapse.”

Rogers, Faber Say Fed Rate Cuts Will Spur a Recession (Update4): “Interest rate cuts by Federal Reserve Chairman Ben S. Bernanke will spur inflation, cause the U.S. dollar to collapse and push the world's largest economy into recession, investors Jim Rogers and Marc Faber said.”

This is ECON 101. I remember sitting in class maximizing and minimizing the areas under curves, shifting demand and supplies lines and otherwise toying with economic models. A couple of months from now this rate cut will have had the effect on the economy of SLAMMING ON THE BRAKES as commodity and import prices do a MOONSHOT.

The average American consumer is going to pay more at the pump as crude and gasoline rise. That plasma TV manufactured in Asia and imported will cost more as the US dollar accelerates its decline. Finally, rates will start to RISE as foreigners pull their capital. Think about it: The Fed fund rate in Canada is 4.5%. The Fed fund rate in the US just dropped from 5.25% to 4.75%. First, the spread is practically gone. Second, the Canadian currency is rising because commodities are rising and the country is running a budget AND current account SURPLUS. Why would the Chinese or anybody else invest in a DECLINING currency at such UNATTRACTIVE yields when they have much better and SAFER options?

“The cause of the problems we have today, they are due to artificially low interest rates, expansionary monetary policies and extremely rapid credit growth that was fueled by a totally irresponsible Fed,” said Faber, who oversees about $300 million as managing director of Hong Kong-based investment advisory company Marc Faber Ltd. “It's suicidal to cut interest rates.

The dollar's going to collapse, the bond market's going to collapse. There's going to be a lot of problems in the U.S.”

Time to let the market digest these developments. Time to see if cooler heads prevail.


Gary said...

The first stages of hyperinflation are normally very positive. Unfortunately both Rogers and Faber while ultimately probably correct have terrible timing. Rogers has been short since last summer missing a huge move in the market. The one commodity that we need to watch is oil. If it spikes then we will get the recession. As long as the powers that be can keep oil rising slowly we'll be OK. Notice how Saudia Arabia was in favor of increasing production. They know the effects of an energy spike will in the long run be bad for them. Chavez on the other hand is an idiot. He's willing to kill his long term potential for some short term gain.

Ben Bittrolff said...

I agree. In the short run: Remove your crash helmet and whip out the champagne. This massive cut is like adding gasoline to the fire. In the long run, 3 to 5 years from now: The end game won't be pretty. I see a lot of similarities here to Japan as their credit and real estate bubble burst.

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The dude is completely just, and there is no suspicion.