Cutting Rates Further Will Only Lead to Disaster

Who wants to be in the shoes of the Federal Open Market Committee [FOMC] on Wednesday? Escalating market pressure for a rate cut collide with a horrible inflation outlook as exploding oil prices start pushing commodities higher. Will there be enough hawks defending at least stable rates, or will the doves led by Nanny Benny cave in to panicking markets and do the worst of all by cutting rates further?

Chances are the FOMC will do nothing in a situation that would require a rate hike if fighting inflation is still a predominant concern which can be doubted in the face of the housing and mortgage bust.

Alan Greenspan once called gold a very reliable inflation indicator. A study that proves gold's high correlation with inflation can be found here. As the oldest currency in the world has jumped to $795 in Asian trading on Monday, it appears the world is headed for markedly higher prices soon. Oil's ascent above $93 is poised to add to the spin of the inflation spiral that can be seen so clearly in basically all commodities. Been to your baker lately?

Americans are destined to get the worst of it all, thanks to a Federal Reserve dollar plunging to record lows against the Euro on a daily basis.

Rollercoasting financial markets still indicate that the credit crunch - what happened to the "savings glut" of 2005? - is only worsening as banks hold back their funds in fear that their interbank counterparties go bust overnight. All attempts to prop up markets with SIVs should be seen as what they are: Vain efforts to pump up unsupportable prices. Where do all these billions come from? Certainly not out of the vaults of rich investors but created with Ben Bernanke's electronic printing press. Banks trying to play in the darkroom to hide the disaster run the risk of getting rimmed.

Cutting rates can be a very deceiving medicine that may work well in the short term. It will lessen the burden of debtors whose adjustable mortgages are set for a hike this fall. But it will not change the fundamentals that have been created by a 7-year streak of reckless deficit policies accompanied by a crumbling US infrastructure and major political and economic shifts around the globe.

The whole mess was created by too much credit. Extending it further will be monetary suicide resulting in sky high inflation.

Comments

[Sumit Batra:]

Stupid Bush policies

2007 Oct 29 05:08 PM

[HARM:]

Very nice summation of the "conundrum" the Fed is facing. Nice to see someone "gets it". Overreliance on cheap credit begets asset bubbles, asset bubbles beget inflation, inflation + post-bubble aftermath begets flight to quality (metals, commodities & stronger currencies).

2007 Oct 29 05:50 PM

[Eurotrader:]

Exellent article... and I totally agree with the opinion as to what got the US into the financial problems in the first place. The only question that begs is what the political and financial establishment will do to keep the window dressing up as long as possible. I am certain that Ben Bernanke is under huge political and Wall Street pressure, just witness CNBC's constant mantra for another "shock and awe campaign of 50 bps..."

The problems of the rate cut is not only summed up in the further buying-power degradation of the US-Dollar and further sharp price advances in commodities, but the fallacy that the very people who have done the macro-economically right thing, US savers, are getting the shaft so that the hypsters of real estate and the Wall Street credit bubble interests can rake in their short-term cash !!! The long-term consequences of the credit bubble and its debilitating effect on investment in the US (by devalueing national savings further) will be felt across the US for the next years.

Access to more and more foreign capital is now the equivalent of the modern financier's crack cocaine. However, Wall Street - the main ticket sellers to the various financial get-rich quick schemes that get perpetrated on the general public and upon failure mopped up by the Federal Reserve or the US tax payer (largely unbeknownst to him or her) - is no longer interested in what is best for the US national interest, as the cry rings out - "Go Global"!!! The economic interests of the citizens of this proud country are going down the tubes along with their home prices and their ability to recoverr from their credit crush, putting seriously at risk their stake in the economic dream that once was creation of capital, rather than creation of debt driven by consumptive madness.

2007 Oct 29 10:17 PM

[Mr B 1:]

It's nice to see this in print. Thank You

2007 Oct 30 04:45 PM

[Eurotrader:]

Exellent article... and I totally agree with the opinion as to what got the US into the financial problems in the first place. The only question that begs is what the political and financial establishment will do to keep the window dressing up as long as possible. I am certain that Ben Bernanke is under huge political and Wall Street pressure, just witness CNBC's constant mantra for another "shock and awe campaign of 50 bps..."

The problems of the rate cut is not only summed up in the further buying-power degradation of the US-Dollar and further sharp price advances in commodities, but the fallacy that the very people who have done the macro-economically right thing, US savers, are getting the shaft so that the hypsters of real estate and the Wall Street credit bubble interests can rake in their short-term cash !!! The long-term consequences of the credit bubble and its debilitating effect on investment in the US (by devalueing national savings further) will be felt across the US for the next years.

Access to more and more foreign capital is now the equivalent of the modern financier's crack cocaine. However, Wall Street - the main ticket sellers to the various financial get-rich quick schemes that get perpetrated on the general public and upon failure mopped up by the Federal Reserve or the US tax payer (largely unbeknownst to him or her) - is no longer interested in what is best for the US national interest, as the cry rings out - "Go Global"!!! The economic interests of the citizens of this proud country are going down the tubes along with their home prices and their ability to recoverr from their credit crush, putting seriously at risk their stake in the economic dream that once was creation of capital, rather than creation of debt driven by consumptive madness.

2007 Oct 29 10:17 PM

[Eurotrader:]

Sorry for the typos - I typed too fast....

2007 Oct 29 10:23 PM

[irondoor91:]

Re: Helping adjustable-rate mortgages with a Fed cut. Sorry, but most of those adjustable rate loans are linked to LIBOR. I understand that at the time some of these mortgages were originated (especially the option-arms) the borrower could choose between a LIBOR-based adjustment or some other basis, such as a 3 mo T-Bill or CD. Since LIBOR has historically been the lower nominal rate, borrowers naturally chose it. Now it is working to their detriment.

2007 Oct 30 11:01 AM

[Malkiel:]

"it will not change the fundamentals that have been created by a 7-year streak of reckless deficit policies accompanied by a crumbling US infrastructure and major political and economic shifts around the globe...
The whole mess was created by too much credit"

It sounds to me like the whole mess was created by the factors you first mentioned: "...a 7-year streak of reckless deficit policies accompanied by a crumbling US infrastructure and major political and economic shifts around the globe." So maybe we should expect to change the political landscape if we want to head off inflation? Maybe whatever the Fed does can only be a drop in the bucket if we don't deal with the other issues, but the targeted effect on the mortgage refinancing crisis may be worth the risk. And being a drama queen and screaming about "Extending it further will be monetary suicide resulting in sky high inflation" doesn't cut it for those of us who lived through REAL inflation in the '70's. We'll have plenty of chances to head off serious inflation, but we may not have a choice about low-level inflation when we choose to accept a weak dollar...

2007 Oct 30 12:01 PM

[calvino:]

Malkiel, friend, don't drag that skeleton out of the closet, become it could start walking on it's own. It took Paul Volker to raise fed funds to eighteen percent to get what you call REAL inflation to calm down. Let us not be so cavalier about the prospects of REAL inflation coming back. In fact let us not even whisper REAL inflation in a dark room. Why snap the tiger's tail Malkiel? And Prudent Investor, Nanny Benny is a misnomer for the proud airman, Helicopter Ben, who never has to worry about propwash flustering his hair. Helicopter is good for short though, just call hime Helicopter, and send a helicopter hat to the reserve bank of Washington so he always has one to wear.

2007 Oct 31 02:20 AM

[steveo:]

Dear Fed: No more rate cuts, please. The only question now is how much I should put into PRPFX or similar fund, whenever a small dip (buying opportunity) comes. Sold all shares of a global fund today.
401K money going mostly into bonds now.
Previous poster... it's all Bush's fault, isn't it? Yeah, Clinton and Greenspan, and too many years of low interest rates had nothing to do with any of this, right? Give me an effing break.

2007 Nov 02 11:37 AM