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Thursday, December 16, 2010

Fed Action Leaves Little Doubt

Fed’s Action Leaves Little Doubt
If anyone wondered if the Fed finally had a handle on America’s economic predicament the recent interest rate spike should dispel any lingering vestiges of doubt. The Fed’s much ballyhooed QE2 seems to have backfired. Instead of lower, or steady, interest rates (the stated purpose for QE2) the very opposite has occurred in a humbling blow to the intellectuals at the Federal Reserve.
Fed Chairman Ben Bernanke came on 60 minutes to assure us he could stop inflation “in 15 minutes” using rate hikes. Mr. Bernanke’s ability to keep rates low to help the sputtering economy is now the question riddling the bond markets. Already having taken the Fed Funds rate to zero Mr. Bernanke’s monetary six shooter is out of “traditional bullets”. The latest ammunition, a mammoth purchase of US treasury debt has unexpectedly had the opposite effect. Over the last three weeks, the 10 year US Treasury bond has seen a historic spike in its rate, over 30%.
Remember when bond prices go down, rates go up. In order to bid bond prices higher Mr. Bernanke announced that he would be stepping in to participate in the auctions (or marketplace) to keep bond prices high. There appears to be only one hitch in his giddy up. The Fed has agreed to buy US Treasury debt with longer maturities. When the folks did their arithmetic, and some figuring, they came to the conclusion Mr. Bernanke was just egging the politicians on, and encouraging Congress to borrow more. A mouth watering Federal Reserve has that effect on politicians. 
Mr. Market is not easily fooled. Inflation fears generated by Mr. Bernanke’s actions set off a selling of US debt (remember lower bond price, higher interest rate).
The risk to our economy is that rates will spike and choke off the fragile recovery. The Federal Reserve’s communistic manipulation of the economy further validates that free market capitalism is able to heal our economy that the “central planning” model. How can Americans have confidence in a process that achieves the exact opposite of its desired result? Mr. Bernanke’s contention on 60 minutes that there was no cost involved in expanding the Federal Reserve’s balance sheet is a troubling insight into how Fed governors view the limit of their abilities.
The Fed is fast losing credibility and thus its grasp of monetary policy. 
The Fed is right about one thing. If interest rates go up now it will be like stepping on the throat of a barely breathing economy on life support; not some overheated recovery. 

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