Bernanke’s Put: Putting The Punch Back Into The Punchbowl!

``The great problem is, of course, how to provide such emergency relief without allowing it to degenerate into permanent relief; how to relieve the extreme distress of those who are poor through little or no fault of their own, without supporting in idleness those who are poor mainly or entirely through fault of their own. To state the problem in another way (as I have earlier done): How can we mitigate the penalties of failure and misfortune without undermining the incentives to effort and success?-Henry Hazlitt (1894–1993) founding board member of the Mises Institute, libertarian philosopher, economist, and journalist for The Wall Street Journal, The New York Times, Newsweek, and The American Mercury.

A surprising 50 basis point cut by the US Federal Reserve sent US equities to a bacchanalian revelry, which spontaneously reverberated across the globe.

Equity bulls were quick to broach on the receding risks of recession and the gridlock in the global credit system as a consequence to the magical stroke of liquidity injection which should keep the shindig going. Analyst Doug Noland quotes a comment of former U.S. Treasury secretary Paul O'Neill ``Fed put the punch back into the punchbowl."

Here is accompanying statement of the US Federal Reserve last Tuesday (highlight mine):

``Economic growth was moderate during the first half of the year, but the tightening of credit conditions has the potential to intensify the housing correction and to restrain economic growth more generally. Today’s action is intended to help forestall some of the adverse effects on the broader economy that might otherwise arise from the disruptions in financial markets and to promote moderate growth over time.

``Readings on core inflation have improved modestly this year. However, the Committee judges that some inflation risks remain, and it will continue to monitor inflation developments carefully.

``Developments in financial markets since the Committee’s last regular meeting have increased the uncertainty surrounding the economic outlook. The Committee will continue to assess the effects of these and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth.”

As we have repeatedly pointed out, the performances of the financial markets has been proven to have the most bearing among the considerations of the US policymakers.

Since our monetary system operates on the standard of revolving leverages, where borrowed money bought even more borrowed money, such requires conditions that would propagate even more dosages of leverage or gearing to sustain the system, hence the Hyman Minsky’s Ponzi financing system or euphemistically the Fractional Banking System.

To subject the system to liquidity deceleration or to a contraction of leverage brings to fore systemic risks; the risks that the Paper Money Standard could unravel. In the words of financial derivatives expert and author of “Traders Guns and Money: Knowns and Unknowns in the Dazzling World of Derivatives” Satyajit Das (highlight mine), ``Risk itself has changed significantly. Financial crises are less and less the result of economic downturns, geopolitical events or natural disasters. They are more and more the result of the structure and activity in financial markets. Financial crises now do not necessarily mirror the underlying real economy. Economic cycles have become less pronounced.”

Therefore, an economy greatly dependent on the kinesics of financial assets would inherently engender policy responses directed at its unceasing benedictions.

For those who propound the latest actuations by the FED as signifying pre-emptive or “proactive” actions eludes the rudiments of such dynamics.

For us, the FED’s unanticipated action could OBVERSELY be construed as a sign of PANIC.

An unchanged rate, regardless of the financial markets reaction could have represented “principled” banking at its finest. On the other hand, a 25 basis points cut could have ACKNOWLEDGED the problem, but seen in the light of CONTAINMENT. However, the 50 basis points cut PLUS a similar cut in the discount rates ACCENTUATED the FED’s apprehensions over the immeasurable and profound ramifications of the credit market seizure contagion! This comes amidst risks of “some inflation”, according to the FOMC statement, which is almost tantamount to throwing gasoline to quench the fire (see Figure 1)…

Figure 1: Barry Ritholtz: Fear of a Dollar Collapse, part II

From analyst Barry Ritholtz (highlight mine), ``Speaking of surges: As you can clearly see above (bottom left chart), the amount of MZM (repos) versus M2 during 2007 is enormous.

``This means that the Fed is "inflating" at a rate faster today than it did right after 9/11, or during the deflationary scare of 2003.”

The inebriate has been given his bottle of whiskey.

For us, the US FED and even the Bank of England’s “nationalization of deposits” of Northern Rock corroborates Nassim Nicolas Taleb’s Ethical Problem; the deep-seated nature of authorities for TREATMENT-based POLITICALLY MOTIVATED policies rather than preventive measures.

As evidence, the US dollar trade weighted index, which fell 1.33% this week (see figure 2), has been sacrificed in the altar of today’s monetary system in exchange for the survivorship of its natural constituents.

Figure 2: fxstreet.com: US Dollar Index Plunges to Multi-year lows!

Daily Reckoning’s Bill Bonner excerpted economists Lewis & Clark poignant remarks whom we quote (emphasis mine), ``It seems intended to bail out the speculators on Wall Street...and the imprudent borrowers in the housing market...but it merely redistributes the losses onto the people who don’t deserve them – the general population of dollar holders, dollar earners, and dollar savers all over the world.”

Where mainstream experts mostly argue on the superficial aspects, particularly the symptoms of social or wealth inequality, a few of them fixate on the root causes…as the great Milton Friedman once said, ``Inflation is a form of taxation that can be imposed with legislation.”