You Can't Fight The Fed

The Federal Reserve sparked a rally on Wall Street Wednesday by announcing that it is allocating approximately $1.2 trillion toward open market operations designed to drive down interest rates. Clearly the Fed succeeded in its primary mission. Long-term treasury rates collapsed by about four-tenths of a percent. The dollar has also taken a hit. I wonder what the Chinese are thinking. If I were a Chinese central banker, I might ask Hillary next time she G5s her way to Beijing for a sales call why Americans shouldn't just finance their own debt if it's as simple as the Fed "expanding its balance sheet" in the form of buying treasuries.

Well, I guess maybe it's not that simple. Thursday and Friday the market took back the Wednesday's rally, but gold hasn't shut down. Gold turned on a dime Wednesday with the Fed's announcement, and continued higher through Friday. Ditto oil, and many other commodities. No, you can't just "engage quantitative easing" whenever the economy slows, and expect the action to be consequence-free.

Which is not to say I'm against attempts to "reflate". In fact, I think the Fed's move is an appropriate response to conditions, at least when viewed through a prism unobstructed by the insanity coming out of the Supreme Soviet and the President Shakedown administration. I know that's a little bit like saying I think the A's will win their division this year, IF everyone has a career year and no one is injured. But what is the Fed in business for, if not to take action to prevent the kind of deflationary spiral which most observers would agree, I think, remains a real possibility?

Indeed, Goldman Sachs chief economist Jan Hintzius said on CNBC this morning that the Fed action is not enough, and further that fiscal policy isn't stimulative enough. So I think we can say that the Fed doing nothing would be broadly considered irresponsible. And as "quantitative easing" is a term used to describe throwing cash into the system by purchasing securities on the open market, it also means "we can't lower interest rates below zero, so all we can do is print money". So that's what the Fed is going to do.

Again, if the root of our current troubles is the popping of the real estate bubble, then Fed action that would surely seem to put a floor under real estate and encourage spending (inflation means spend now, it'll be worth less later; deflation means don't spend now, it'll buy more later) seems rational. And I fully expect the markets to react well in the near to medium term. But the longer term problem is that the Federal Reserve's monetary policy isn't being applied in a vacuum. It must be viewed through the prism of the political class' fiscal policy.

When President Reagan was first elected, our nation faced economic peril which I am still contending far exceeded today's. If our current situation deteriorates to a point that it is worse than the depression of 1980-1982, then it's because instead of having a President Reagan, we have a President Shakedown. When President Reagan took office, inflation was the growth killer, because expectations of future inflation kept interest rates high. The solution was to kill inflation, but stimulate non-inflationary growth (through tax cuts). In other words, revive animal spirits, and allow risk-taking on new technologies and methods generate new wealth without printing money.

Currently, the growth killer is deflation, so we need to re-inflate, but with a bias, again, against inflationary growth. That means a bias against wasteful government spending, and in favor of entrepreneurial risk. As we are already seeing, simply inflating has consequences - if not (yet) in terms of rising interest rates, then in terms of higher commodity prices, which will impede growth rates, and thus re-employment. And, in contrast to the way in which Fed Chairman Volker's anti-inflation jihad of the early 1980s magnificently complemented Reagan fiscal policy, now we have a Fed Chairman who quite properly has signalled that he will do what it takes to prevent deflation, but who is paired with an administration that is hostile to capital, investment, and entrepreneurial risk. Thus, as Dennis Gartman repeated Wednesday after the Bell, it's still time to invest in things "that if you drop them on your foot, it hurts". You may be albe to throw out a government in two years, but you can't fight the Fed.