The fed

[Randy Cresap]

So what is with the fed? Its job is not to relieve investors from the
consequences of risky investments. Economies go in cycles.
Recessions happen, and if they don't, then the economy builds up to
bubble-bursting moments -- that is, without the creative destruction
of capitalism and the pruning of the dead wood from the economy,
things go from bad to worse, because why not act like risk doesn't
exist when the fed will jump in to manage stock prices?

Yet here the fed is, acting like it's supposed to engineer the economy
by lowering rates whenever the stock market drops -- regardless of
what it does to the currency, and regardless of what happens to
inflation. In other words, it's nothing but political pandering --
and now investors have the expectation that when the stock market goes
down, the fed will jump in to make it go back up by lowering rates.
Predicting rate cuts from the fed has become more important to some
investors than what's going on with the actual companies or debt
instruments that they're buying. Talk about divorced from reality.

I have the same problem with these economic stimulus packages -- i.e.,
the tax rebate, which is the same as raining cash down from a
helicopter. It assumes that recessions aren't an important part of
the economic cycle. It also assumes that recessions can be avoided.
Ridiculous. I say let it happen, sooner better than later when things
can really get worse. No use sending us further into debt in a
pointless attempt to fend off the inevitable.

Instead, the fed is only making things snowball -- increasing the
debt, undermining the dollar, and increasing inflation, all for
short-term political effect.

The mechanism is as follows:

1) The world is on the front end of the popping of a global credit
bubble. There are so many derivative instruments -- such as the bonds
backed by subprime mortgages -- that the "paper" money far exceeds the
amount of "actual" money / assets world-wide. It's sort of like when
the 1929 stock market got so pumped up because everyone was trading on
margin without any "real" money to back it up.

2) The whole thing has to unwind -- i.e., there have to be defaults,
until the amount of credit is proportionate to the amount of
underlying economic activity. This has happened in cyclical fashion
throughout history.

3) The fed, by lowering interest rates, is instead increasing the
money supply, financed by the U.S. going deeper into debt and by
devaluing the dollar (more dollars in circulation relative to the same
amount of assets means each dollar is worth less; also, with lower
interest rates, foreign buyers like China will pay less for treasury
bonds, particularly since the deeper national debt makes the risk of
constructive default -- the further depreciation in the bond's value
by inflation / the loss of value of the dollar -- more likely.

4) The fed intends to keep the flow of money going, causing the credit
bubble to go even higher, until eventually there is a correction in
the currency -- inflation (short term), or even eventual deflation.

So instead of letting capitalism run its course, and letting the
insane financial industry learn the lessons that every generation has
to re-learn about every 20 or 30 years -- that playing with money
involves risk -- the fed listens to the poor Jim Cramer types and
lowers rates.

There has to be a credit shakeout. There have to be defaults.
Otherwise we're looking at a volatile dollar (inflation / deflation).
And it's Back to the 70's.

Anyone agree? disagree?

[Louis Jeansonne]

Randy,

For once, I agree with you.  In fact, the arguments you made are exactly why I do not believe the common axiom that government intervention can "smooth out the bumps" of the economy.  In fact, I think that the fed's manipulation of interest rates actually serves to exaggerate the natural peaks and troughs of the economic cycle, because the fed reacts more intensively, yet more sluggishly, than a free market would (no matter how smart Greenspan was, he wasn't as smart as the collective brain of everyone). 

I say, get rid of the Fed and let banks set their own interest rates.  In this age of LendingTree.com and other comparison sites, they would all gravitate toward one common competitive national interest rate automatically anyway.

[Randy Cresap]

Lou, I do think that there are times when, for example, there's a
temporary liquidity crisis that makes the fed important (which has
happened, for example, in 1998 and possibly in the last few months, if
we ever get to hear the whole story); and it was the Volcker fed that
"conquered" inflation back in the early 80's. But my big problem is
not with its existence; it's with the current policy / expectation
that it should *directly* intervene in the markets, instead of
sticking to simple monetary policy. The markets are not its business.
Neither is the economy as a whole. It's money supply, which may have
an effect on the other two, but only an indirect effect.

The institution and its chairman is so front-and-center right now that
it has a direct effect on the markets -- market drops, people look
breathlessly to the fed to see if it will make the market go up again.
Its primary influence is now through the media and investor
psychology than anything else. Because there are so many people that
believe that things get "priced into" the abstract "market," anytime
the fed lowers or raises rates people have a knee-jerk reaction now
and believe that the indexes will go up or down -- and that the
federal reserve chairman magically made it happen by pushing a few
interest rate buttons. So now it's far more influential (and I also
blame Alan Greenspan's celebrity) than it should be, to where its role
has become "manager of the economy" or "manager of the markets"
instead of "manager of the federal reserve bank."

So I think it's more of the federal reserve becoming too involved and
overstepping its authority, rather than a problem with the federal
reserve system itself. Whether the federal reserve system works (that
is, your questions about whether smoothing out economic changes) is
another question that is simply too confusing for me to even think
about. In other words, is some continuity economically better than
having occasional sharp ruptures / market panics?

Finally, Lou, you shouldn't be too surprised at agreeing with me --
I'm pro-capitalist, pro-free market, I just also think that things
like social responsibility also are part of the equation in government
-- that is, unlike a corporation, government's purpose is not maximum
profit, but governing, and at some levels the free market must take a
back set to other interests.