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The Un-Credible Fed

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Problems too big to bailout.

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The other day I was musing that perhaps the Fed has lost the bond market. Meaning that the Fed is understood to be fueling inflationary fires, and even though it can take short rates down, it won't be able to affect long rates.

Of course, making a statement like that is always bold, because you're never going to know if it's true until well down the road. And, even though that statement may look like it's true in the short run, it may in fact not be.

That said, I've been struck by the media's recognition (finally) that we have an inflation problem. And, given its understanding that the Fed is clearly in a box -- destined to ease (in an attempt to stave off economic weakness), while continuing to honor the Greenspan put (as far as equities go) -- folks are now beginning to realize that the Fed's predicament will only increase the inflationary pressures.

Of course, the Fed will say that if the economy weakens, it will take pressure off inflation. And, a tanking of world GDP would do that to some degree. But this would only be of limited help. A serious amount of economic weakness would be needed to counteract the money-printing that has chased the price of almost everything higher. This is the psychological component that Jim Grant called "money of the mind" (which he wrote about so eloquently in his book of the same title).

It takes many years for a certain psychological mindset to plant roots, and generally that state of mind is resistant to change. But it does appear that psychology regarding inflation has changed, and that the Fed is in the process of losing the bond market. One has only to look at the explosive rise in 30-year fixed-rate mortgages to see that the Fed' campaign of easing has backfired. A knowledgeable friend in that business tells me this is one of the worst periods ever, as those rates have just rocketed higher, even as the Fed has eased.

Greenspan and the Fed created this mess by picking the wrong interest rate -- and by continually bailing out every problem created by excess money-printing with more excess money-printing. But we're finally at the moment in time where the problems are too big to bail out (periodic upside flurries in stocks and belief in magic wands notwithstanding).
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