I'm With You, Ben, on This Cut (and the Next)

Includes: DIA, QQQ, SPY
by: Accrued Interest

I'm a believer in two things when it comes to monetary policy. First, it is in the best interests of everyone that long-term inflation remains contained. Therefore the Fed should be primarily focused on inflation most of the time.

Second, debt deflation is extremely dangerous for modern economies. I believe (and Ben Bernanke believes) this is what caused the Great Depression, and if we were to experience another Depression, debt deflation is the likely culprit.

The current housing market could cause a debt deflation-type event. Falling housing prices put mortgage holders in an increasingly negative net worth position. It could spiral out of control: bank failures, credit unavailable, etc. Do I think this is a high probability event? No. But it could happen.

This is why I support continued Fed cuts. Does it make sense that the Dow would fall 300 points just because the Fed cut 25 instead of 50? Perhaps not. I mean, the Fed could cut 50bps at their next meeting and accomplish the same result. So I don't think the 25bps cut today indicates the Fed is behind the curve or that they are ignoring the risks I've discussed above.

But we do need continued liquidity from the Fed to ensure that the debt deflation scenario doesn't come to pass. If the result is a little extra inflation down the road, so be it.

Look for the Fed to continue cutting until it's clear that the debt deflation risk has passed.