Thursday, March 19, 2009

Helicopter Ben's Latest Trillion

Yesterday's 2.1% rise in the S&P500 Index was mostly fueled by Fed chairman Ben Bernanke's promise to add a trillion dollars to the Fed's balance sheet via quantitative easing.

Faced with a 0% interest rate, all the Fed can now do is to pump money into the US and global financial markets by purchasing financial instruments.

But, as I wrote in this post earlier this month, where is the money coming from? By what means will investors continue to value US dollar obligations as the Federal Reserve either prints more money or borrows more money with which to buy more questionable assets from US financial institutions.

This approach may have led to a one-day equity market rally, but, longer term, it has to have inflationary implications. And that, of course, is bad for equities.

In a healthy US economy, or one in a normal recession, the Fed can command sufficient confidence to add liquidity to the economy without necessarily causing long term economic damage via inflation.

But the US economy is currently deleveraging in the midst of a recession. What Bernanke is proposing, in conjunction with the federal government's many spending plans in excess of several trillion dollars, is to essentially releverage our economy.

But isn't that what we now believe was a mistake? Private over-leveraging of our economy led to unsustainably low interest rates which fueled bad lending and overconsumption of housing.

Isn't Bernanke's solution of adding a trillion dollars to global capital markets just repeating, with government money, what was viewed as a mistake by private markets only last year?

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