Drunken Horses and Drunken Horses' Asses in Academic Wonderland

The stock market and commodities are rallying once again over the upcoming QE announcement. Every bit of news, no matter how trivial, supportive of what everyone already knows (that QE is coming), gets market participants get more excited every time.

Will the actual announcement of what we all know result in the biggest sell-the-news event since the Fed's interest rate cut in January of 2001?

While pondering that, please consider Fed Minutes Lend Weight to Stimulus

The minutes of the Sept. 21 meeting of the Federal Open Market Committee indicated that several officials “consider it appropriate to take action soon,” given persistently high unemployment and uncomfortably low inflation.

Now, with unemployment near 10 percent and with inflation well below the Fed’s unofficial goal of nearly 2 percent, the Fed is considering renewed intervention: creating money to buy long-term Treasury debt. That would put additional downward pressure on long-term rates, making credit even cheaper.

Former Fed officials interviewed on Tuesday appeared to be just as divided as the current ones.

“If you lead the horse to water and it won’t drink, just keep adding water and maybe even spike it,” said Robert D. McTeer, who was president of the Federal Reserve Bank of Dallas from 1991 to 2005 and is a well-known inflation “dove,” particularly attuned to the harm of joblessness. “You definitely don’t want to take the water away.”

H. Robert Heller, a Fed governor from 1986 to 1989, had the opposite view, urging the Fed to show restraint.

“I would do nothing,” he said, expressing concern that the Fed might appear to be “monetizing the debt,” or printing money to make it easier for the government to borrow and spend.

“If they start to monetize the federal debt, they will dig themselves a much deeper hole later on,” he said. “That’s what we learned from the 1970s, when the Fed undertook a very expansionary monetary policy. It took a double recession in the early 1980s to wring inflation out of the economy. We don’t want to repeat that.”

William C. Dudley, president of the Federal Reserve Bank of New York, recently raised the possibility that inflation could be allowed to run above the implicit target for some time in the future, to make up for inflation today being lower than desired. That could temporarily raise inflation expectations and lower real interest rates.

Economic Illiterates Trapped In Academic Wonderland

Only the back end of a horse would think that adding water or alcohol to an ocean of liquidity will solve anything. The fact of the matter is small businesses are the economic driver for jobs, and small businesses will not expand even at 0% interest rates.

For details, please see NFIB Small Business Trends for October Continue to Show No Recovery, Inflation Not a Threat; Fed Governor Hoenig Blasts Bernanke's QE Strategy
Rising commodity prices

It would sure help if the economic illiterates at the Fed would get out in the real world and talk to small business owners.

But they don't and they won't. Instead they sit in their academic wonderland of Monetarist stupidity that says if horses won't drink, give the horses more water and if that does not help, offer them whiskey.

Moreover, William Dudley, proves he has as much sense as a beached whale with his suggestion of higher inflation targets.

Small businesses are already crucified by rising input prices in the face of falling demand and falling prices for their goods. They need customers not higher input prices.

Imagine what would happen to the economy if there was a price shock and the price of oil doubled. Would that cause an increase in the demand for loans? Of course it wouldn't. However, it would crucify those on fixed incomes.

The problem is not falling prices, but falling demand for loans. We are in this mess because of overleveraged consumers, businesses, and financial institutions. Just as you do not cure an alcoholic by offering him another drink, you do not cure a problem caused by excessive liquidity, still more liquidity.

Lowering interest rates does more harm than good as both Hoenig and now Robert Heller, a Fed governor from 1986 to 1989, have suggested.

For now, this QE is supportive of the stock market and commodity prices. Unfortunately, it adds to the problems in the real economy, and it surely adds to the Fed's exit problems down the road. Ultimately, this experiment will make Ben Bernanke one of the biggest horses' asses in history. Until then, party on.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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