A periodic blog dedicated to providing commentary and encouraging debate on topics in Economics and Finance.

About Me

Age: 26 Occupation: Private Equity

Wednesday, October 31, 2007

Feddie Krueger Cuts'em again!

OKAY.... Given that it is Halloween today, I just had to work Freddy Krueger into the mix... and the Fed has made that quite easy by slicing and dicing the federal funds rate and discount rate with all due ferocity.

Why is Mr. T in there? Well, Mr. T rules... more on that later.

Today, the Fed reduced its target federal funds rate (the rate at which banks borrow from each other) to 4.5%. How do they do this? They print money and lend to banks at 4.5% as much as is necessary to "defend" their target rate (Just trying to educate, so Mr. T does not pity you.)

All in all, I have to say that I'm in favor of the recent move, despite my distaste for artificially low interest rates, and I am most impressed with the Fed's strategic maneuvering over the last few months.

Why do I applaud their maneuvering?

First, they shocked the market in August by cutting the discount rate by 0.5%, which stopped the bleeding from August's "global margin call" or as some would call it a mini "Minsky moment." They also stepped up to the plate with loads of liquidity to make sure the credit markets didn't totally explode.

Second, the Fed cut the funds rate by a more-than-expected 0.5% in September, which (i) dramatically reduced pressure in the credit markets by lowering borrowing costs for struggling banks and making existing yields more attractive, (ii) helped sure up bank income statements due to reduced interest expense and (iii) aided interbank liquidity, continuing to ensure that the credit markets didn't totally explode.

Finally, they made sure that, after today, they wouldn't be "forced" into lowering rates again by setting proper expectations from the outset. The key phrase in their statement released today:
"The Committee judges that,
after this action, the upside risks to inflation roughly balance the downside risks to growth."

This is a clear signal (as clear as you can get from the Fed) that the committee believes that, while not the case for this particular cut, any further cuts will cause inflation to become of greater concern than slow growth, meaning that they don't plan on cutting rates again unless it gets uglier out there.

BRAVO! The Fed has finally BECOME AN EFFECTIVE TOOL, moving from a reactionary implement of Chinese water torture that simply drips down the economy's forehead 0.25% at a time to a proactive hammer with the capability to shape and mold (and maybe even do a mean "typewriter"). As you see, Feddy Krueger is acting more like Mr. T and our dear friend M.C.
I have far more confidence in Bernanke than our buddy "easy Al." Greenspan's fed "Can't touch this" one.

Another reason why I love the rate cuts is the devaluation of the dollar. Other countries have been devaluing their currencies to prop up their economies for quite some time (instead of, you know, improving productivity or leveraging comparative advantage or investing in capital). It's about time we get to use this easy way out of economic distress. They can buy the living daylights out of our artificially cheap stuff and send all of their jobs here for once. After all, we're looking at probably 2-4 more years of housing pain... we need the help.

Will the new Fed hammer, a sizzling global economy and a sickly dollar be enough to keep us out of a recession despite years of reckless lending and misallocation of capital? Will it be able to overcome the fact that millions of debt slaves (oops, I meant "people") are being stretched thin by their retarded mortgages because they paid too much for their slowly rotting boxes (oops, I meant "homes")? I don't think so, but Bernanke, I believe, will aid in us achieving the best outcome possible given the cards we've been dealt.

Full text of the Fed's statement:

Release Date: October 31, 2007

For immediate release

The Federal Open Market Committee decided today to lower its target for the federal funds rate 25 basis points to 4-1/2 percent.

Economic growth was solid in the third quarter, and strains in financial markets have eased somewhat on balance. However, the pace of economic expansion will likely slow in the near term, partly reflecting the intensification of the housing correction. Today’s action, combined with the policy action taken in September, should help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and promote moderate growth over time.

Readings on core inflation have improved modestly this year, but recent increases in energy and commodity prices, among other factors, may put renewed upward pressure on inflation. In this context, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Charles L. Evans; Donald L. Kohn; Randall S. Kroszner;
Frederic S. Mishkin; William Poole; Eric S. Rosengren; and Kevin M. Warsh. Voting against was Thomas M. Hoenig, who preferred no change in the federal funds rate at this meeting.

In a related action, the Board of Governors unanimously approved a 25-basis-point decrease in the discount rate to 5 percent. In taking this action, the Board approved the requests submitted by the Boards of Directors of the Federal Reserve Banks of New York, Richmond, Atlanta, Chicago, St. Louis, and San Francisco.


ghu206 said...

Good post... love the inclusion of Mr. T.

Yes, this Fed appears to be better, but, as you say, not good enough.

dxm113 said...

Wow! Informative and entertaining!!!

But honestly...do you really think that fed's "funny money" policy is the best way to help the economy? How does devaluing the dollar help the economy?

Wouldn't it be better to raise interest rates and stop printing money instead? Wouldn't that drive up the value of the dollar, and drive investments to the US?

P.S. you for got to mention Peter Gabriel dropping the "Sledgehammer"

eternitus said...

Long-term, I think the decline of the dollar is inevitable as long as foreign countries peg the value of their currencies to ours. They manufacture and maintain imbalances in trade through continuing to "buy" dollars and purchasing our bonds... making long-term rates artificially low... which causes inflation and dollar depreciation... I think foreign countries have contributed handily to mess we're in.

As you seem to be... I'm an advocate of zero money supply growth and the gold standard... So I know that the dollars I earn aren't going to steadily lose value over my lifetime (Check this out... What's your return from the "great" ING savings account?

4.3% - 1.5% (yep, it is taxed) = 2.8% - 2.8% (inflation - just reported... I think actual for me is much higher) = 0!

I have to earn 4.3% on my money just to maintain the purchasing power of my cash after taxes.

But, since we aren't going to get a gold standard and zero money supply growth, I think it's only fair that we use the "exchange rate game" to our benefit for a while. The game has been one-sided for two long.

__k said...

I also favor a gold reserve standard.

I had high hopes for the Bernanke Fed, but I've been disappointed lately. (Well, it's still much better than Greenspan's.) What's the point in doing all this to avoid a recession? Barely being in a recession is only slightly worse than barely not being in one. Why can't it be better in the long term to have a brief, minor recession, if it leads to good growth sooner by correcting the fundamentals more quickly?

Here in Maryland, the ING return is more like: 4.3% - 1.85% (taxes) - inflation = loss. And a lower target rate means an even lower yield, likely accompanied by greater inflation, for an even greater loss. Thanks, Feds.

eternitus said...

I agree 100%,
And thanks for not ripping on me for using the words "two long" instead of "too long." Shame on me.