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Fed Signals “All Systems Go” for More Inflation

Economics / Quantitative Easing Nov 07, 2009 - 07:22 PM GMT

By: Mike_Larson

Economics

Best Financial Markets Analysis ArticleI have been adamant recently in saying that the Federal Reserve would not … would NOT … signal an end to the easy money environment at this week’s policy meeting. These guys simply lack the political willpower and the inclination to do what’s right. They want to keep the booze flowing to inflate assets, the long-term consequences be darned.


Sure enough, the Fed reiterated Wednesday that it’s not worried at all about the surge in asset or commodity prices. It said,

“Substantial resource slack [is] likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.”

Not only that, the Fed also said it will keep rates low until the cows come home. Specifically, it said that it …

” … continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels of the federal funds rate for an extended period.”

The FOMC isn't worried about inflation.
The FOMC isn’t worried about inflation.

The only change the Fed did signal? That it’ll buy up to $175 billion in so-called “agency” debt, slightly below its previous target of $200 billion. But it’s still going to buy $1.25 trillion in mortgage-backed securities.

And it’s not buying fewer bonds issued by Fannie Mae and Freddie Mac because it suddenly realized the folly of “monetizing” U.S. debt obligations …

… it’s because of the “limited availability of agency debt” to buy. In other words, the Fed is afraid it’s cornering and distorting the market … which it is!

Never Forget: “Proactive” Is A Dirty Word in Washington

Why have I been saying you should forget the empty talk you’re hearing about tighter policy? Because action is what counts. And it is abundantly clear to me that the Fed won’t take action until it’s forced to by a dollar crash, a bond market collapse, or some combination of both.

Those events would be important signals that the market has lost confidence in the Fed’s ability to control inflation and in the U.S. government’s willingness to preserve the value of the dollar, necessitating a policy response.

“Proactive” is quite simply a dirty word in Washington. Politicians (and this includes Fed members, no matter how much they like to pretend they’re not political creatures) don’t like to move before a crisis … only after one gives them the political cover to do so.

Indeed, history is clear: Rather than proactively tighten monetary policy in the late-1990s to quell the insane speculation in tech stocks, the Fed ignored the bubble until it gutted the portfolios of millions of investors. Then the Fed ignored the 2003-2006 housing bubble until it ruined the lives of millions of homeowners.

The Fed just told the markets to let the good times roll!
The Fed just told the markets to let the good times roll!

Now, the Fed is doing the same thing again, but on an even grander scale. It’s inflating virtually every asset under the sun — junk bonds, corporate bonds, gold, commodities, stocks, you name it. And rather than proactively taking steps to control the markets … before they get OUT of control … they just told the market this week to let the good times roll!

Regulators, Congress looked the other way while Fannie, Freddie, and mega-banks drove themselves off a cliff!

It’s not just Fed policymakers. It’s the banking regulators and Congress, too!

Look at Fannie Mae and Freddie Mac. People were warning for years that they were taking on too much risk … that they were too thinly capitalized … and that a housing crash would bury them.

But Washington allowed the two agencies to go on their merry way, piling up huge amounts of debt and risk. We all know what happened then: They blew up, requiring tens of billions of dollars in taxpayer-funded bailout money.

Ditto for the banks that were making reckless, high-risk home equity loans, mortgages, and commercial real estate loans. Many observers, including us, were shouting from the rooftops that this would end in disaster.

But rather than shut down the lenders making these loans, or FORCE them to cut back on their risky lending, all the regulators did was issue mealy-mouthed “guidance” letters. The banks ignored them because they had no teeth. And not too long after, those banks began to fall like dominoes.

Bottom line: I don’t LIKE the Fed’s current policy of asset inflation. I know it’s going to end in tears. But until those events I mentioned earlier (currency crash, bond crash, etc.) occur, forcing a change in policy and leading to a shift in momentum, the only thing we can do as individual investors is play along and try to make as much money as possible.

Until next time,

Mike

P.S. Are you getting my intra-week updates on Twitter? No? Then what are you waiting for! Just go to http://www.twitter.com/realmikelarson and subscribe to this free service.

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