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We're not going over a cliff with a 2 percent Fed funds rate

Monday, October 06, 2008

Or are we? Those words were spoken by Robert Dye, a senior economist at PNC Financial Services Group in Pittsburgh, Pennsylvania in this story at Bloomberg today and it probably captures the sentiment of most stock investors.

Cut rates! What harm could it do?

A half-point cut to short-term rates would certainly give equity markets at least a temporary boost and the whole idea of remaining vigilant against inflation is, quite frankly, starting to look kind of silly with commodity prices tumbling and home prices in free-fall.

Oh, that's right, home prices aren't included in the government's misguided measure of "inflation" and food and energy are stripped from the economists' preferred gauge of consumer prices, both of these errors sure to go down in the economic history books as being much more grave in retrospect than in real-time.

Anyway, they're starting to talk about deflation again (or at least dis-inflation) - that's when central banks are supposed to start cutting rates with abandon.

Deflation Threat Returns as Asset Markets Decline
As Federal Reserve Chairman Ben S. Bernanke and his global colleagues fight the worst financial crisis since the 1930s, one danger is looming larger by the day: deflation.

With asset markets tumbling, commodity prices plunging the most in 50 years and banks keeping a tighter grip on credit, the ingredients for a sustained period of falling prices are coalescing. While inflation is still a concern for many policy makers only months after oil and food prices peaked, the risk is their patchwork of rescue and stimulus packages will fail, and prices will start to fall throughout the broader economy.
Prices are already falling in parts of the world economy. Home values dropped more than 10 percent in the U.K. and in the U.S. in the past year. Oil, copper and corn drove commodities toward their biggest weekly decline since at least 1956 on Oct. 3, with the Reuters/Jefferies CRB Index of 19 raw materials tumbling 10.4 percent. The Baltic Dry Index, a measure of commodity shipping costs, has dropped 75 percent since May.

"We are certainly more worried about deflation than inflation," says David Owen, chief European economist at Dresdner Kleinwort Group Ltd. in London. Central bankers need to "get rates down and keep them there for quite some time,'' he says.
Without the benefit of having seen today's more than 700 point almost 800 point plunge on the Dow, Mr. Dye notes at the end, "What's the point in holding back?"

Good question.

Ambrose Evans Pritchard is much less respectful of recent monetary policy in this report in today's Telegraph noting in the subtitle that "unless there is immediate intervention on every front by all the major powers acting in concert, we risk a disintegration of global finance within days. Nobody will be spared, unless they own gold bars."

One more reason to buy some gold - if you can find any...
Germany takes hot seat as Europe falls into the abyss
Investors will learn today whether the Paulson bail-out - fattened to $850bn (£480bn) by Congress - can begin to halt the death spiral in the credit system. So far, the response looks terrible.

Germany is now in the hot seat. The collapse of a rescue deal for Hypo Real Estate on Saturday threatens a €400bn (£311bn) bankruptcy that nearly matches the Lehman Brothers debacle for sheer scale.
Drastic rate cuts would be a good start. Central bankers still paralysed by a misplaced fear of inflation – whether in Europe, Britain, or the US – have become a public menace and should be held to severe account by our democracies. The imminent and massive danger is now self-feeding debt deflation.
IMAGEThe lesson of the 1930s is that any country trying to reflate in isolation will be punished. The crisis will ricochet from one economy to another until every one is crippled. We are seeing it play again in this drama as our leaders fail to rise above their narrow, parochial agendas.

The European Central Bank – which raised rates into the teeth of the crisis in July – has played a shockingly destructive role in this enveloping slump. Its growth predictions this year have been, and still are, delusional. Neglecting its global role, it has vastly complicated the fire-fighting efforts of Washington.
There is much more from Ambrose in his characteristically caustic style along with more than 200 reader comments at the Telegraph.

Equity markets surely need something.

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Evan said...

I didn't know that Bernake's middle initial is S. That makes him B.S. Bernake, how appropriate. Anyhow, I think that while deflation hurts, for those who hold cash and don't have much debt lower prices would be welcome. I see no moral reason why those people shouldn't subsist vs. those who live above their means. (Although I know the problem is that Uncle Sam lives above his means and sets a bad example). I think we're seeing that somehow our dollar value needs to remain constant despite politics or what have you. Sounds like an argument for sound money to me. Although I don't know how much of this is deflation vs. bubbles--if something just plain costs too much, then stay out of the market, don't buy it, until it costs less. Pisani kept chanting "Buy Potash!" but it couldn't go on to rise in price forever. Eventually it got to a point where it just cost too much to own.

Anonymous said...

As I'm sure you know, Tim, Bernanke wrote in his thesis on the depression that the real core of the problems was a tightening of the money supply. The conclusion then being that the best way to avoid something like that in the future would be to shovel money out the Fed's door, and into the hands of banks and businesses, early, often, and in great amounts.

You should perhaps dig up that thesis again, considering how things are going - it's not that long, and you could surely find some choice quotes from it.

Not to be, you know, too alarmist, but all the central banks working together, and globally united to keep shovelling money into the economy... a low-productivity, risk-averse, volatile, overinventoried economy... sounds like a great way to let everyone continue to do their ultimately useless business of the day... while the wealth of society spirals, unnoticed, into so much waste heat and unmarketable goods. Hey, if you keep giving me those dollars, I'm going to keep building these suburbs and SUVs!


The latest from Jim Kunstler seems to capture the spirit of the day.

Mathlete said...

First off, they should abolish the Fed, or at least have a 0% inflation target, with the understanding that printing money=inflation.

But if we have to keep the current system of CPI targeting, they ought to include home prices and stock prices, measured by trailing 12-month P/E.

Then again, why not a pure Commodity-Asset model. It seems that we either get higher resource prices or higher financial assets whenever there is inflation, and those prices go up before and consumer prices.

But what do I know, the only bubbles I've blown are with soap wands and bubble gum.

Anonymous said...

what is the difference between deflation and return to the mean?

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