Deliberating the Fed's Exit Strategy

Former Fed economist and current Morgan Stanley (MS) Asia Chairman Stephen Roach Sees "Great Risk" in Fed Exit Strategy.

The Federal Reserve may cause another crisis by botching the withdrawal of liquidity from the US economy … Roach said.

The Fed is the "weak link" among central banks and may fail to tighten monetary policy in time to stop asset bubbles from forming, Roach said at a conference in Berlin [on Saturday]. The Fed helped trigger the boom and then bust of the subprime mortgage market by being "quick to slash, slow to normalize" interest rates, he said.

"There is a great risk in the coming exit strategy," said Roach, a former Fed economist. "They are lacking primarily a political will to execute the exit in a timely and expeditious fashion that will avoid the mistakes of the last crisis." The traditional view of central bankers that asset bubbles are hard to spot and deflate with rates is "ludicrous," he said.

"This is a failed flaw in the intellectual construction of modern central banking that must be addressed," said Roach. "If we don't fix this problem we're doomed to repeat the failed asymmetric policies of the past and set ourselves up" for another crisis.

Roach recommended the Fed be required to "hardwire" the goal of preserving financial stability into its mandate, alongside the pursuit of full employment and low inflation. Central banks should not be "allowed to outsource their responsibilities" to regulatory bodies, he said.

Fed Is Fatally Flawed

The Fed is fatally flawed in many ways. Stephen Roach (who I happen to like) misses a lot of them. For starters, the only source of inflation is the Fed and fractional reserve lending.

The best policy would be to get rid of the Fed and fractional reserve lending entirely in favor of a stable money supply. That would fix the problem of inflation once and for all.

The case against the Fed and fractional reserve lending is easily made. Please read Fractional Reserve Lending Constitutes Fraud for a brief overview.

More importantly, please see:

• Factional Reserve Banking by Murray Rothbard
• Case Against the Fed by Murray Rothbard

"Case Against the Fed" is 162 pages, but very easy reading that anyone can understand if they just give it a chance.

Fed Uncertainty Principle

As noted in Fed Uncertainty Principle, the Fed distorts the economic picture by its very existence.

The Observer Affects the Observed

The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg's Uncertainty Principle, where observation of a subatomic particle changes the ability to measure it accurately.

To measure the position and velocity of any particle, you would first shine a light on it, then detect the reflection. On a macroscopic scale, the effect of photons on an object is insignificant. Unfortunately, on subatomic scales, the photons that hit the subatomic particle will cause it to move significantly, so although the position has been measured accurately, the velocity of the particle will have been altered. By learning the position, you have rendered any information you previously had on the velocity useless. In other words, the observer affects the observed.

The Fed, by its very existence, alters the economic horizon. Compounding the problem are all the eyes on the Fed attempting to game the system.