Forex Traders'  Instablog

This is the question asked by many traders who want to tie the purported beginning of the bull market to some real fundamental improvement in the economy. As the economy moves out of the slump, it is argued, the Fed will be forced to admit that it cannot keep rates at where they are for long without kindling the risk of rampant inflation. And as many propose that we’re witnessing the end of the recession, it is only a matter of time that the Federal Reserve realigns itself with the changing facts and acts in accordance. In fact, traders in Fed Funds Futures are giving a better than even chance that Mr. Bernanke will raise rates above the abysmal 0.25 percent by January.

How likely is that? Our position is that this economy is being sustained by easy money and speculation and nothing else. Certainly, the unwillingness of the Federal Reserve to raise rates even a tiny level above the 0-0.25 band, in spite of the recent impressive rally in almost all markets is a clear sign that they concur to this analysis. Let us remember that monetary easing has been going on since September 2007. We’re close to August 2009, and there is very little sign that the Central Bank’s easing of credit has translated to any pick-up in investment activity, or consumer spending. Monetary policy is having little effect because the economy has reached a “money saturation” point in the last two years. Contrary to the theories of Friedman, and his colleagues at the Federal Reserve, unlimited supply of money does not always lead people to do something (invest, employ, consume etc.). Sometimes it just causes asset appreciation which fails to generate confidence because people are aware that behind the façade of wealth generation at the financial markets, there is just a little bit of “nothing” going on in the real world of real economic activity.

Mr. Bernanke himself is at an important crossroads in his career. But a different version of the same small-scale doom is awaiting the U.S. economy regardless of the path he takes, and he is sure to acquire a unique place in the annals of the Federal Reserve, right aside Mr. Arthur F. Burns who presided over the institution in the 70’s, no matter what he does. If he succeeds in preventing the economic misery that is threatening to overtake the American economy, if he can help the U.S. avoid a depression, he will have done so at the cost of an incredible, unimagined debt burden that must still be paid somehow with shrinking tax revenues and increasing commitments. Ironically, if American policies help the Chinese to transform their economy into one that is less based on exports, one of the major purchasers of Treasury bonds will have less cash and incentive to bail-out the American government. Eventually, a collapsing dollar, and economic turmoil will be the outcome. If he fails, and a depression takes hold, it is unlikely that the external position of the government will be that big a problem, but the cost in unemployment, despair, and economic inertia will be just as severe. The result will still be turmoil and mayhem, but in a different form.

Our position at ForexTraders.com has always been that the behavior of the Federal Reserve and government is mostly irrelevant at this stage of the crisis. They can turn a chimera into a dragon, a sphinx to a Cyclops, but eventually, no amount of financial and economic wizardry will suffice to somehow sweep away the problems of the global economy, or to turn back the clock. Only the natural course of events, the sufferings that must be born, the chaos that must be experienced will create the conditions for the eventual rebirth, but that is a long way away from here, for now.