The [Un]expected Fed move

This is the guest post made by Andy Bebut from the Yellow Brick Road blog

Today the Federal Reserve made a surprising move to increase the discount window rate by 0.25%. The move is already covered in all respectable financial blogs so I feel necessary to add my 2 cents.

The first thing to keep in mind is that this move is truly symbolic. The outstanding discount window credit is something like $14 bln, virtually nothing. This rate doesn't mean anything really.

So what it is? It's a message, which I want to discuss. 

The typical reaction of the average blogger is that Bernanke is crazy anyway and is not aware that the economy is struggling, is living in his dream of 5% GDP growth and is already discussing the exit strategy. Well, if that's true there is not much to discuss, crazy is crazy.

But my axiom is that Bernanke knows the economic situation better than the average blogger and his economic knowledge is unsurpassed. And his move makes a lot of sense. In fact, if I can imagine myself as a member of a voting committee I would vote "for".

The kludge to understand what I'm going to say is in this perfect interview by Andrew Smithers. He is suggesting that the top priority of the Federal Reserve must be to prevent any asset bubble, even if it means another recession soon enough. The best rate of he economic growth would be just 1%-3%. If we overstimulate the economy and start growing at 5%+ it may end badly, because such a growth will inevitably produce another asset bubble. When it pops the economy will enter the even worse recession than we had in 2008.

He is saying that the stock market is overvalued by about 40% and another 10% up will end with disaster. What is needed badly at this stage is to slowly deflate the bubble in stocks, commodities and gold. After the prices decline they must not be allowed to grow ahead of the fundamentals.

He also suggested that the paranoiac fear of deflation is not warranted. Just a bit of deflation, under -1%, will not hurt at all but will help contain bubbles and ensure slow growth.

I perfectly know that the 4Q GDP growth was bogus. And Bernanke knows it very well. But still, if we have to pop the stock market bubble, it's the best time to do before this growth subsides. 

The whole purpose of this engineered rally was to allow the financial sector to sell new shares and raise much needed capital. It is done, mission accomplished. Those who were unable to raise capital when S&P was at 1150 are hopeless anyway. Now this game is over and the priorities had changed. The healthy 15% correction and $50 oil is what we need now. 

Let see if it works.


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hello abebut!

I'm so glad you posted this here because I was debating on what this raising of the discount window really means, especially with respect to the carry trade.

I don't know if you looked at the carry trade in all of this yet.

Ok, while I think deflating asset bubbles, in particular commodities, with heavy focus on oil/energy futures (because that will just plain cripple the economy as it did in 2008),
is critical,

I do not see precisely why this would work that way, but this is a first pass comment, I need to go read the delveraging through deflation link again.

But secondly, I don't see why we cannot shoot for a 5% GDP growth or even higher and have that be any issue. But it would be "what kind" of GDP growth. I mean yes if exports suddenly ballooned that would imply heavy increase in raw materials/energy/commodities...

but hell man, wouldn't that one be worth it (minus kick out the speculators those bums)?

Another would be capital investment, is that so god awful here?

I mean I think 70% of an economy being some sort of glorified coneheads mass consumption scenario is beyond stupid, and I can see an asset bubble with that...

but I don't see it being so bad with investment and a jumpstart/kick start of the real economy, i.e. production.

Also, there is this minor thing called people suffering and out of income/job.

Does it matter - the printing press is still printing

Vegas, the place that was built in a desert, a place that is/was a boom town type of place. Will propping up something that can't be naturally sustained a good thing? IMO eventually the rates will go up and go up a lot more than I care to think about. God I hope we don't go back to Jimmy Carter days. I just have the feeling it is coming.

I am really looking into gold. I did the same back in the Carter days, gold and silver. I remember the line in San Francisco was around the block waiting to get into Deak-Perera. I met several other friends waiting in the same line.

"Obama to tout housing help Friday in Las Vegas -
President Barack Obama is unveiling $1.5 billion in housing help, a boost timed to his appearance in the city with the worst foreclosure crisis in the nation."

The PTB will not, no way no how, change their ways of bribing and paying of those they need to for votes. Both sides have their favorite payoffs. Since it is taxpayer money, do we get a say in the pay offs? No I didn't think so.

Production? True production, the capital producing stuff like manufacturing are not on the radar of our beloved elected officials.

No Effect on Oil Prices

Any real measure that would slow things down would have lowered wholesale oil and gasoline. Instead its up quite a bit from last week.

Is this the same Bernanke who knows the economy SO WELL that he completely missed the crash? Oh yeah thats him. Financial services and economics where failure is rewarded. The closest thing to a meteorologist.

The 5% - 6% growth at this

The 5% - 6% growth at this point is dangerous because it will blow the next asset bubble much faster than we'll have time to enjoy this growth.

When that bubble pops it will destroy economy into greek state.

The slow growth will be followed by a mild recession.

Just read that 12 pages interview I posted. It's amazing.

just read it

and I agree and we almost in my view were hit with two asset bubbles, oil as well as housing (but well, is a House of cards of derivatives an asset bubble?)

But maybe I'm just too uneducated, but I notice the dot con era and what he calls subsidies, I'm assuming he means private (in a way) subsidies but the evaluations were not real, the companies on flimsy ground, business models that made no sense and so on.

So, maybe I'm wrong but to me it's not "all or nothing" in terms of jump starting innovations.

I do not believe one has to have such stuff to get innovation although assuredly one will have a lot of broken eggs, but to limit the expectations and the investments...

I mean one does not need $12M first round VC with a powerpoint business plan, there are many ways to spawn innovation and resulting new industries without that particular system (Which became more motivated by pre-IPO and dumping your shares as fast as possible afterward than any great technological breakthrough and the "next killer app")

So, I don't see some strong growth in some elements of the GDP as long as it's sustainable and real.

i.e. instead of giving everyone and their brother VC funds or making backroom deals with guaranteed pre-IPO stock and the rest of it, how about stringent requirements that this investment is sustainable, real, long lasting?

Another thing I'm gravely worried about is unemployment. This "new normal" is simply unacceptable and something has to give. I hate to say this but I know one way they could assist without putting economic growth in overdrive and that is to limit the labor supply, mainly through immigration (reduced) and they could also bring back some of the offshored jobs and it would help unemployment but not overheat the economy.

What can I say, something has to give and they cannot let 20% of the middle class sink into oblivion, talk about a long term problem.

Thanks for bringing this up, it's kind of outside my knowledge sphere so I went reading up.

I'd say a lot of folks on this site at least are heavily focused on the production economy, trade policy anc such, but monetary policy as well as global finance, something I certainly need a better education with.

"The paranoic fear of deflation is not warranted"?

What does this picture say to you?