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We’re getting closer to the point discussed a few weeks ago about markets giving up on the Fed.

At the time the 10 year was maybe 3.75-3.80, gold had gone about 1,200, the dollar was near the lows, crude was back over 80, stocks were up, all based on the belief the Fed had the power to ‘reflate’ and was ‘printing money’ through trillions of ‘quantitative easing’ which was, sooner or later, hyper inflationary, along with 0 interest rates and ‘record deficits’ which would drive up interest rates, risk default and a sudden breakdown of the $US, all contributing to the same inflationary collapse.

Now that the bets have been placed, and none of that is happening, it’s all starting to erode. Crude is back below 75 (the Saudis’ actual target/range?), gold is selling off, the dollar is edging higher, the 10 year just traded at 3.57, stocks are selling off, etc.

The next step is for first markets and then policy makers to realize the Fed has no tools to inflate. That 0 rates and qe don’t cut it. Nor are deficits large enough to reflate. Bernanke was asked by Time magazine late last year if he had any tools left. He said yes. When asked what they were, he had no specific answer. Well, if he does have more tools, with 10% unemployment and weak prices and a dual mandate for full employment and price stability, what’s he waiting for?

Should market psychology turn to the notion that the Fed has no tools to inflate, and we have a Congress dead set against larger deficits, it can all get very ugly very quickly in the race to the exit from the inflation plays (including steepeners) currently on the books.


8 Responses

  1. I wouldn’t be surprised if Bernanke uses gold as the buffer stock. That’s one legal (and probably popular) way out for the monetary authority to act as a fiscal power.

  2. If we do have a ‘second wave’ it should be short-lived. Perhaps this is wishful thinking but I’m not going to bet against it.

    “We are not going to have a second wave of financial crisis,’’ Geithner told National Public Radio. “We cannot afford to let the country live again with a risk that we are going to have another series of events like we had last year. That is not something that is acceptable.’’


    “We will do what is necessary to prevent that, and that is completely within our capacity to prevent,’’ he said.


  3. The is not a business cycle but a long financial cycle, ending in the Ponzi finance stage that is still exploding, leading to continuing debt deflation that the Fed is not able to reverse successfully. It’s likely the markets are soon going to forget about “the danger of hyperinflation” that the inflationistas have been pumping and start hedging against deflation. Warren is right. There will be a race for the door to unwind inflation hedges.

  4. Did you see this?


    It does open the door to negative interest rates on reserves. Probably, they would have to do some type of separate payment through a different lineitem as the computers are probably not setup to accept the idea of a negative interest rate.

    I know, I know, lending isn’t reserve constrained. but this would compel the banks to take that money out of the fed – and once that happens, people start to want it to make a little money.

    Also, they are talking about using the rate on reserves in the context of raising the rate. Yikes.

    1. They don’t need to lend for the banks to reduce excess reserves. They can just buy Tsy’s and get a bit of interest instead of having to paying it on excess reserves. There really is no way the Fed can force the banks to lend.

      1. On the other hand, the federal government could lend (or spend) directly. But I suppose that might conflict a bit with the president’s new “spending freeze” plan.

        They’re like a bunch of medieval doctors. The weaker the patient gets, then clearly the more the patient needs to be bled to get the humours in balance.

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