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Moral Hazards


I have been struck by the seemingly relentless chin scratching going on ahead of the Fed meeting today. Parsing the nuances of the adjective "considerable" and whatever, if anything, replaces it, to determine the direction of interest rates and overall economic activity in the next few quarters? Huh? Does this feel to anyone else but me to be an exercise in utter fantasy?

That the media have endorsed and promulgated the view that the Fed "directs" the economy is not new news. But by now almost every participant in the markets - investment professionals included - are serving up that same piffle. And it's extraordinary.

Why? Because the Federal Reserve does not direct the economy. There I said it. Yes, they can create greater or lesser incentives for spending or saving over the short run; by inflating and passing the "benefits" of inflation on to their trusted intermediaries (banks and brokerage houses), they can skew the balance of spending vs saving in the short run. Murray Rothbard described this policy on those unlucky enough to be downstream from Citibank and Goldman Sachs for what it is: a tax pure and simple. And that intervention creates all sorts of moral hazards. The beneficiaries of the reflation (those closest to the liquidity injection) come to expect it and thus, alter their appetites for risk taking, The hard and fast logic of economic utility gets thrown out the door.

Over any intermediate amount of time, however, you can be sure that, as Mr. Practical suggested by way of John this AM, they remain slaves to the forces of global capital flows and confidence just like you and I. And that's when the hazard part of the phrase moral hazard will start to matter. So when the navel gazing about whether considerable means considerable (or something else entirely) ends, don't forget that complex systems cannot be "managed". To think so is to engage in the most slavish form of oracle worship.
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