Tuesday, June 24, 2003

Easy money promises to just get easier tomorrow as the Fed is roundly expected to cut the US Federal Funds rate to 1.0%, and perhaps as low as 0.75%. Yet this is among the bluntest of tools to try to fine-tune a wildly imbalanced national and global economy, and the more likely consequences are surely not going to be to the liking of Greenspan & Company.

Thus another representative of finance capital comes out today in the FT to critique the Fed's "increasingly desperate attempts to steer the US economy away from deflation". Since the Fed must keep long-term interest rates ultra-low in order to keep the US housing and thus consumption bubbles from bursting and the massive US federal budget deficit financed, it is in the process encouraging a bond market bubble and moreover commiting itself to stop any possible bubble burst at all costs. As Barnes observes,
This is extremely powerful stuff. Essentially, the Fed is telling the markets to have a party because the punch bowl will stay in place for a long time. Moreover, if the party starts to get too dull, the Fed will add another bottle of booze to the bowl.
Now that's great writing.

More bubbles seem to be inevitable in the current environment. Attacking one only feeds another. And in case we haven't noticed, bubble management hasn't been Greenspan's strong suit -- viz. the 1994 bond market and the 2000-02 stock market.

In Barnes' view,
The Fed's aggressive efforts to steer the economy away from deflation will be conducive to mini-bubbles in a range of asset markets. The Fed does not necessarily want more bubbles to grow but they are seen as an acceptable price to pay.
The matter at hand is of course whether the new bubbles created by the Fed's loose monetary policy will generate only "mini" bubbles or whether, as Barnes himself notes,
You may know that it makes no sense to buy Treasuries at current yields but the game is worth playing if you can get out before the mass of investors. The fact that many investors undoubtedly take the same attitude sets the scene for dramatic marke reversals down the road.

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