Recalling Basic Economics

I had an interesting conversation at my fitness club the other day with an acquaintance who is in the accounting/consulting field. We were discussing the current economic situation, and he asked me, to paraphrase,

'What do you think of the notion being circulated that Bernanke is pursuing QE2 and low rates in order to drive equity market prices up, to make businesses and investors feel better, so to better spark a real economic recovery?'

I replied that, if true, it's a misguided approach. I noted that, for those who recall their basic economics, we're now in a classic Keynesian liquidity trap. Rates aren't driving investment and, if anything, as I've written in some prior posts, are likely to fund marginal, unwise projects, because of the ultra-low rates and their inability to include adequate risk pricing.

We discussed the wasted so-called stimulus spending and added deficits, neither of which have really affected the unemployment rate.

It was then that, in answer to my colleague's question concerning what should have been done, I repeated my belief that banks and other firms, e.g., GM, contrary to auto czar Rattner's contentions, in need of capital should have been allowed to properly enter a formal Chapter 11 process. Profitable operations would have been protected and either spun off or sold. Unprofitable operations would have been liquidated, which is what Citigroup and GM subsequently did. Merging failed banks is no longer a major issue, given FDIC deposit insurance. This myth that large-scale bank failures cripple the economy persist only so long as government and industry officials allow it to perpetuate.

Once you've insured depositors, what's the risk? Loans are transferred or sold. Operations are transferred and merged. Shareholders lose, which is appropriate. Bondholders line up in order of seniority, according to bankruptcy law.

Where's the problem? We're overbanked in the US as it is.

Then I touched on the inequity of government's enforcement of a mortgage foreclosure moratorium. How unfair it has been for existing owners to be given breaks, while equally-deserving buyers at the true, lower market-clearing housing prices are denied the opportunity to do so. Which only delays a true housing recovery.

Anyway, my colleague agreed with my suggestions. But, further, I recalled for both of us some more basic economics, i.e., you can't have recoveries without real recessions. You can't have the release of resources- capital and labor- without the liquidation of failed firms. If firms aren't allowed to fail, resources don't experience the necessary Schumpeterian recycling into new uses.

We can't experience robust economic recoveries without full economic recessions. Despite politically-originated attempts to chop off the downside phases of economic cycles, we can't always be in an expansion. Real capitalistic economies have expansions and contractions.

King Canute couldn't stem the tides, and our government can't rewrite economic laws to eliminate periods of economic contraction.

Low-Rate Environments & Bank Profitability

Yesterday's Wall Street Journal finally published an article detailing how low interest rate environments hurt bank profitability.

My banking education dates from my first days at Chase Manhattan Bank in the early 1980s. Schooled on asset-liability management and repricing, I recall quite clearly that low-rate environments are worse for bank lending and asset management profitability than higher-rate environments.

Evidently, that hasn't changed in thirty years.

Thus, since 2008, banks already pressured by bad mortgage-related loans, securities and derivatives began to be squeezed by the Fed's lower interest rate policy.

The Journal story provides details of various banks and asset managers coping with slimmer margins. What the piece doesn't discuss is two other important phenomena which add to lower overall profitability of this environment.

One is, obviously, the greater probability of asset bubbles, against which loans may be made, in low-rate environments. We just saw this over the last seven years. Now rates continue to hover at record lows.

The second aspect involves risks versus rates. At ultra-low rates, projects of marginal merit appear to be worthwhile and may be funded. Yet they are precisely the most vulnerable loans, once rates begin to move upwards towards more normal, sustainable levels.

This will leave banks holding more problem delinquent and/or defaulted loans. It's a major reason why so many banks reportedly aren't lending now in the first place.

Of course, idle capital which is unlent is employed in money markets, which now is about the same as cash, i.e., the classic Keynesian liquidity trap.

Welcome to the world of low-profit banking so long as Helicopter Ben continues to hold rates near zero.

A Downside of Low Interest Rates

Earlier this week, the Wall Street Journal ran an article discussing a somewhat hidden downside to the US economy's current ultra-low interest rates. That problem is what such rate levels do to assumptions driving pension fund values versus long term liabilities.

Simply put, companies- and states, for that matter- are facing much greater shortfalls in their pension funding. For example, the article cited GM sources as saying that "every .25 percentage-point decline in its discount rate could increase its pension obligation by about $2.4 billion."

That obligation as "underfunded by $17.1 billion at the end of 2009."

On a larger scale, the article noted,

"If S&P 500 companies took account of the interest-rate decline as of Aug. 31 to calculate their pension-fund balances, the combined deficit would increase by about $167 billion, or nearly two-thirds more than the year-end 2009 deficit of about $260 billion, estimates Jack Ciesielski of the research firm Analyst's Accounting Observer."

Leave it to the free market's checks and balances to identify this risk. Between suspect private sector growth rates inhibited by government interference, taxation and deficit policies, and these low interest rates, one wonders how any ground will be gained on these pension liabilities.

Down the road, of course, this could morph into lower demand and savings, as retirees don't collect expected pension payments.

US Debt Levels & Interest Rates

Jason Trennert wrote an interesting little editorial in Friday's Wall Street Journal reminding us of the nature of short-term funding, and the folly of relying on it.

He ends his piece with a quote from Hemingway,

"In this context, it might be wise to remember Hemingway's Mike Campbell from "The Sun Also Rises," who, when asked how he went bankrupt, responded, "Gradually, then suddenly." "

Trennert is doing us all a service by reminding us of what happened to Bear Stearns and Lehman. When markets lose confidence, what was gradual bankruptcy, often in the form of higher interest rates and shorter lending maturities, suddenly becomes no funding at all.

He notes that the US Treasury has shortened our funding cycle to the point that we now owe "$5.2 trillion due in the next three years out of the $8.3 trillion outstanding."

That's more than 60% of our total outstanding debt, with much more being anticipated from increased deficits in the coming years.

Trennert also tells us that the current weighted-average funding cost is 1.21%- an absurdly low rate for the condition of the US government's financial situation. Much of that ultra-low rate is due, no doubt, to two factors. One, the massive holdings of US dollar-denominated debt by global investors, so that they can't easily just stampede out of dollars. And the lack of a viable, liquid alternative of sufficient capacity to absorb inflows if/when dollars are dumped.

Trennert notes, sagely,

"But the time to secure long-term funding is when you can and it is mildly expensive, not when you have to and the costs are exorbitant."

Or worse, you have to, and there is no cost at which you can extend your debt maturities.

To begin cutting our debt levels, the US will have to either save more, invest less. Both of these will slowly erode our GDP growth rates.

But continuing to rely on global investors to absorb ever more US debt with no end in sight is foolish.

Our current administration may, or may not, as Trennert points out, be using short-term funding to disguise the real costs of debt. But reliance on such short-term funding is ill-advised and too risky when betting on the ability to continue to place US debt while increasing its deficits.

But recent average 5-year note rates are 3.77%, roughly triple the current weighted-average, which would add $133 billion to the US government's annual interest rate bill.

Treasury Rates Rising Above 4%

Is inflation coming?

Treasuries finally broke the 4% yield mark earlier this week. Could this finally be evidence of the beginning of inflation?

Let's not quibble about commodity prices and such. I mean Friedman's view of inflation-

"everywhere and always a monetary phenomenon."

The gap between the Fed's rate setting and the market's is now looking pretty significant. And, in the long run, markets tend to win that fight.

In hindsight, it will be easy to see the massive federal borrowing and dollar creation of the past two years as inflationary.

There are, to be sure, various arguments concerning relative safety of currencies. In that view, dollars are still more trustworthy than any other currency. So, at the end of the day, investors will still hold dollars.

But so many new dollar-based obligations have been created recently that it fairly screams 'depreciating dollar!'

What investor wants to explicitly buy an asset that can so easily be depreciated by its creator? And that's so clearly what is going to happen to the dollar in the years ahead.

When has the Fed ever managed this sort of withdrawal from a position of such over-creation of dollars?

Volcker wasn't correcting an over-supply of dollars, so much as breaking an already-existing psychology of inflation. And rates were much, much higher.

Now, we have a still-sluggish economy and a Fed seemingly hooked on dollar creation, at whatever cost, to prop up an increasingly-statist economy.

How is that something that is desirable or able to be easily ended?

David Malpass On Near-Zero Interest Rates

I like David Malpass' clear, simple economic thinking and analysis.

In today's Wall Street Journal, he points out the damaging effect of Ben Bernanke's Fed's continued maintenance of near-zero interest rates.

Simply put, we know that high interest rates attract investment capital. So the Fed's current insistence on low rates drives capital overseas, starves non-financial US uses of capital, and actually helps delay the onset of any economic recovery.

With all of the Congressional debate over Fed independence and Bernanke's reconfirmation as Fed chairman, we're seeing him choose unwisely for the US economy's long term health.

Too-low US interest rates distort capital allocations, promote funding of projects which won't be profitable in normal interest rate environments, and when they exist at the same time that other countries' rates are higher, facilitate capital migration out of the US.

Malpass is correct in calling for the Fed to ignore Wall Street and raise rates. It's not like current low rates are creating jobs or producing a healthy economic recovery.

Maybe trying something more sensible would work?

Interest Expense of the US National Debt

I read a piece in the Wall Street Journal yesterday by Lawrence Kadish that left me stunned.

Kadish uses CBO and Bureau of the Public Debt figures to sketch out a horrifying scenario.

At the end of last month, the US national indebtedness stood at nearly $12 trillion. Interest expense for this year on that amount will be $383B.

Kadish then uses CBO figures to derive this year's estimated personal income tax payments as around $904B. Dividing the interest expense for this year into personal income taxes, he derives the shocking rate of more roughly 40%.

True, one could use the estimated $2 trillion government receipts for 2009 instead, making the figure a more palatable 19%. But, in reality, taxes are always and ultimately borne by people. Institutions merely collect taxes indirectly for governments.

Kadish goes on to note that the US government has run deficits constantly, except for those few years of the elusive "peace dividend" following the USSR's breakup, for decades. So, predicting to the mean, or prior behavior, it probably will try to do so going forward, as well.

Now, due in part to the recent financial meltdown and global flooding of liquidity by central banks, interest rates on Treasuries are currently around 3%. But in the Carter years, it was as high as 15%.

Now add in OMB's projections of deficits amounting to some $9 trillion over the next decade, meaning a near-doubling.

You can see the awful mathematical conclusion, can't you? If rates move up, as they most certainly will as liquidity is drained globally, and too many dollars require ever-higher rates on US Treasuries, the current nearly $400B interest tab could easily swell by a factor of at least 5- twice for the larger debt level, and 2.5 times for the interest rate effect.

Will US per capita income rise by five-fold in a decade? Unlikely. Unless you mean purely through inflation. Real incomes certainly will not. If the US economy grew at a steady 3.5% each year and it was all due to productivity, meaning the entire gain went to increase personal incomes, they would only grow by about 40%.

Kadish goes on to state,

"Eventually, most of what we spend on Social Security, Medicare, education national defense and much more may have to come from new borrowing, if such funding can be obtained."

The options, Kadish writes, will become default or hyperinflation.

In prior decades, when our debt was widely held by western powers and investors, our appetite for social programs hadn't reached its current level. Longer ago, the US dollar was a prized, stable store of value in the post-WWII era.

Now, the world's major growth economies are no longer friends, e.g., China, Brazil, India. They won't necessarily even do us the favor of lending in dollars. If so, it will be at exorbitant rates.

Kadish's final point is to cite Steve Forbes as saying that the national debt is one issue which will motivate US voters to take action on Washington's profligacy.

I believe that. But on the way there, it's going to get very scary.

Imagine explaining to the average taxpayer that his annual tax liability is nearly half-consumed for just interest on our borrowing to pay for our lush social programs. And we're adding more, by the way.

And that, in a few more years, that figure will be easily more than half. So Washington will continue to try to borrow abroad to pay for promises it is increasingly unlikely to be able to keep to all parties- citizens, investors, and other countries.

Perhaps this is why I'm finding less to write about in the corporate world these days than in the world of Washington-centric business and financial dealings.

What Ben Bernanke Didn't Tell You In His Editorial

Fed Chairman Ben Bernanke wrote a long editorial in Tuesday's Wall Street Journal, appearing the morning of his Capitol Hill testimony, entitled "The Fed's Exit Strategy."

You see, many people, including me, doubt that the Fed can effectively avoid rampant inflation caused by its monumental explosion of the US money supply and guarantees.

Ben patiently attempted to reassure readers by listing the many ways he feels the Fed can rein in much of the liquidity it recently created.

Here's the one thing Ben never mentions in his editorial.

All of the methods he described involve raising interest rates.

Whether it's by paying higher interest rates on bank reserve deposits, selling Treasuries, or any of the other approaches he outlined, they all necessarily involve boosting interest rates.

It's fundamental economics. Money supply down, rates up. Pushing securities into investors' hands via sales pushes those prices down, thus raising effective interest rates.

You know what rising interest rates tend to do?

Yes, that's right. Choke off recoveries and slow economic growth.

Granted, rates are basically at zero for now. But they are at zero with much, much more US obligations outstanding than ever before. To move the needle on these massive obligations, interest rates will have to rise.

Oh, yes. That's right, the rate the US pays on its debt will...have to...rise.....too.

Oh, my. Doesn't that raise our cost of government and the deficit?

You betcha!

Thanks for the tutorial, Ben. Next time, maybe be more honest about the effects trying to shrink the money supply will have on the economy's effective interest rates?

The Long Term Consequences of Unending US Bailouts of Private Sector Companies

This is the first part of a loosely-envisioned two part series of posts.


The larger topic, which will be the subject of the second post, concerns the long sweep of US economic and business experience from post-WWII to now. How our larger corporations and senior business executives have had incomplete, sheltered and misleading experience such that, in times of challenging circumstances, few of them are qualified and experienced to manage through this environment. And, most importantly, since the days of FDR's Social Security program and the Truman-led wage and price controls during WWII, our society has engaged in deferred promise-making on a scale never before seen in recorded history.


What happens when those two themes collide, and our society cannot possibly fulfill economic promises made by various groups to each other, and, sometimes to ourselves? When promises made in anticipation of straight-line GDP growth and naive hopes of everlasting corporations meet realities of economic cycles, coincident capital market panics and economic recessions, bankruptcies, and temporary value destruction in both real and financial assets?


But, to today's topic,

What might be the global implications and consequences of the ongoing, large-scale US Federal government's Federal Reserve and Treasury outpouring of US dollars, through both borrowing and printing?

I've been pondering this since the TARP bill was conceived and fought over in Congress.

If one were viewing the global financial implosion of the past year from outside of the environment, like some sort of Einsteinian 'thought experiment', what would one have seen, and what conclusions might you draw?

On a broad scale, the US financial markets would have begun to dramatically lose value, beginning with the 'mark to market' impacts on and of the two failed Bear Stearns mutual funds in the summer of last year. As trading ceased in various structured financial instruments composed of mortgages, the most recent of which were increasingly lower-quality 'alt-a' and subprime in nature, the market value of many financial assets plunged, as financial institutions began to sell better assets in order to either raise cash for redemptions or take gains to offset 'mark to market' losses in the structured financial instruments.

Having started, globally, with above-average leverage, financial institutions bearing these losses had comparatively less equity capital with which to absorb the now-outsized losses on exotic securities and, increasingly, more mainstream equities.

As confidence lost in structured finance instruments spread to those institutions operating outside of the Federally-supported banking system, i.e., investment banks, brokerages and hedge funds, their equity values plummeted, counterparty risk rose, and leverage across the entire global financial system effectively began its inexorable shrinkage.

Since leverage, a function of debt, implies confidence in the future returns of loans placed with various enterprises, its unwinding corresponds to a loss of such confidence. The forced reduction in this leverage began, understandably, with the short-term borrowing instruments of both financial and non-financial instruments- commercial paper, most notably.

As this massive de-leveraging of fixed income instruments occurred, the simultaneous drop in real estate values and equity market values caused several consequences.

First, large-scale losses in US, and other nation's market, i.e., societal capital stocks, valued notionally, plunged. Those who previously owned the capital suffered large losses. In the US, the Treasury and Fed moved to support the Federally-registered banks via direct preferred equity purchases and, separately, takeovers of Fannie Mae, Freddie Mac and AIG.

From our external perspective, then, it was as if, following the observance of massive equity and debt capital losses in US society, and others holding US instruments, the US government, choosing to believe that earlier, higher values, were justified, to some extent, simply printed more money and issued liability instruments in order to reflate the financial sector and, indirectly, the business economy.

Whether those choosing to hold US government debt would feel this was purely inflationary, or merely a transfer of wealth from those whose capital value had evaporated, to the US government, is, to some extent, still to be determined.

Yesterday's plunging T-bill yields suggest that, for the moment, the market seeks safety in notes issued by the government of the globe's largest, most free economy, more than it cares about the debauching of the value of the dollar.

The second major consequence of the calamitous drop in price of many stores of value- real property, equity, debt- coupled with the deleveraging, was the cessation of bank lending. Thus, a financial crisis, partially unleashed by a narrowly-defined 'mark to market' rule in a single US law, Sarbanes-Oxley, led to the real effects on non-financial sectors of the US economy. As banks struggled to deleverage their assets in order to both conserve remaining equity from further losses, and abide by regulatory capital requirements, lending suffered. This became a self-fulfilling act, as, starved of normal, short-term operating liquidity, more and more businesses began to reduce operations and cut staff.

The third unforeseen consequence, then, to complete the circle, was the rising joblessness as the economy was already softening, of its own accord, by early 2008.

This last link in the circle of economic causes and effects has now driven a dramatic drop in consumer spending, due to: rising unemployment, lower home values as a source of personal household net worths, and lower financial asset portfolios as a source of personal household net worths.

Viewed again from a perspective outside the global financial and business system, the effect of the market and economic events of the past 18 months has been to dramatically reduce overall investor and consumer confidence in near-term investing and employment conditions, leading to rapid deleveraging and, thus, a reduction in effective money supply.

Since, by Fisher's equation, MV=PO, the fall in the effective quantity of M, assuming, at best, a stable V, must drive a reduction in physical output, price levels, or both. It is now becoming both.

To reverse this effect, as any economics student, Treasury Secretary or central bank chairman knows, assuming velocity has fallen, as has been observed via the freezing of bank lending, M must rise at the rate which one desires PO, or global nominal GDP, to rise.

And that is why central banks are flooding the globe with liquidity, heedless now of later inflation. And, given the notional destruction of so much original capital value, as of early 2007 levels, it is not clear that there will be a consequent inflation. There's simply less market-valued capital and current production available to drive said inflation.

Thus, having fleshed out this thought experiment thus far, to our current situation, what might be the most likely answer to my initial question?

For now, it seems that the flood of US-government-printed dollars will not lead to near-term inflation. And, absent another country of with a democratically-elected government, reasonably-stable protection of property and other rights, the economic size and diversity of the United States, it seems global investors have little choice but to buy and hold the dollar for the foreseeable future. What are their other options, the Euro or Yuan? Hardly.

If there had remained an investor or consumer group totally outside of the now-globally-interdependent economic and financial services web, the US might soon experience a rapid decline in the dollar's value, skyrocketing interest rates, and a loss of appetite for US debt- publicly and privately issued. In short, a severe comeuppance for the largest single economy on the globe.

But that doesn't actually appear to be in the cards, thanks to such tight, fast global interdependencies.

How the US government conducts its retreat, assuming it makes one, from the various large-scale intrusions into the financial and banking sectors, and exchanges its investments for cash which is returned to the Federal Treasury, will govern how the longer term effects of its massive funding efforts have an impact on US and global inflation.

Fed Rate Action

In this post a little over a week ago, I cited the errors which I think Bernanke's Fed has recently made, including,

"To date, it's unclear that any of the extra Fed-supplied liquidity has affected the credit markets in a substantial, lasting manner. Instead, equity markets have reacted to the various rate cuts like heroin addict to his latest fix. After the effect wears off, he looks for the next dose, hoping it will be even larger.

The editorial points out that the Fed is notoriously bad at what used to be called "fine tuning." In this case, knowing when to suddenly switch from recession-fighting rate cuts to inflation-fighting rate hikes seems likely to be problematic."

Now we learn that the Fed will certainly cut interest rates at least 50bp tomorrow, with market expectations having reached a full percentage point, or 100bp.

What the heck is going on here?

The Fed's rate cuts going back to this summer haven't exactly lifted either the economy or financial markets out of whatever difficulties they are experiencing. So what will an additional one percentage point cut accomplish?

Brian Wesbury opined, in a discussion on CNBC this afternoon about Bear Stearns, that, ironically, the Fed's rate cuts had helped to drive the firm out of business. Wesbury noted that rates were falling on various risky assets, as the Fed lowered rates, while risks remained high. As returns no longer matched or compensated for risks, instrument prices tanked.

The result, for 'mark to market' securities, which composed much of Bear's book, was a rapid contraction of value.

The Fed's recent actions regarding accepting various types of paper at its windows for discounting, including now allowing non-commercial banks access to these facilities, seems appropriate to me in this market.

But further stoking of inflation through needless rate cuts seems to me to be a major mistake.

Feldstein On Today's US Economic Dilemma

Last week, in Wednesday's Wall Street Journal, economist Martin Feldstein wrote an editorial entitled "Our Economic Dilemma." In his piece, Feldstein echoed several of my own themes from this recent post, which, in turn, drew on comments and writings from people such as Brian Wesbury and Bill Wilby.

For example, Feldstein wrote,

"But these past recessions were caused by deliberate Federal Reserve policy aimed at reversing a rise in inflation. In those cases, the Fed increased real interest rates until it saw the economic slowdown that it thought would move us back toward price stability. It then reversed course, reducing interest rates and bringing the recession to an end.
In contrast, the real interest rate in 2006 and 2007 stayed at a relatively low level of less than 3%. A key cause of the present slowdown and potential recession was not a tightening of monetary policy but the bursting of the house-price bubble after six years of exceptionally rapid house-price increases. The Fed therefore will not be able to end the recession as it did previous ones by turning off a tight monetary policy."

Clearly, Feldstein believes, as do I, that Fed rate cuts just won't do that much for whatever currently ails the US economy. It's my guess that if you asked Feldstein directly whether the Fed's rate cuts will have done much more than stoke future inflation, he would say "no."

He continues in his editorial,

"The unprecedented national fall in house prices is reducing household wealth and therefore consumer spending. House prices are down 10% from the 2006 high and are likely to fall at least another 10%. Each 10% decline cuts household wealth by about $2 trillion, and this eventually reduces annual consumer spending by about $100 billion. No one can predict the extent to which the coming fall in house prices will lead to defaults and foreclosures, driving house prices and wealth down even further. Falling house prices also discourage home building, with housing starts down 38% over the past 12 months.

But the principle cause for concern today is the paralysis of the credit markets. Credit is always key to the expansion of the economy. The collapse of confidence in credit markets is now preventing that necessary extension of credit. The decline of credit creation includes not only the banks but also the bond markets, hedge funds, insurance companies and mutual funds. Securitization, leveraged buyouts and credit insurance have also atrophied.

The dysfunctional character of the credit markets means that a Fed policy of reducing interest rates cannot be as effective in stimulating the economy as it has been in the past. Monetary policy may simply lack traction in the current credit environment."

Here, Feldstein explains that the unwise over-expansion of housing, and, by implication, the funding of said over-expansion with opaque CDOs, have resulted in real losses of wealth that will likely affect consumer spending. Thus, growth will at least slow, even if not reverse us into a recession.

Summing up, Feldstein writes,

"There is plenty of blame to go around for the current situation. The Federal Reserve bears much of the responsibility, because of its failure to provide the appropriate supervisory oversight for the major money center banks. The Fed's banking examiners have complete access to all of the financial transactions of the banks that they supervise, and should have the technical expertise to evaluate the risks that those banks are taking. Because these banks provide credit to the nonbank financial institutions, the Fed can also indirectly examine what those other institutions are doing.

The Fed's bank examinations are supposed to assess the adequacy of each bank's capital and the quality of its assets. The Fed declared that the banks had adequate capital because it gave far too little weight to their massive off balance-sheet positions -- the structured investment vehicles (SIVs), conduits and credit line obligations -- that the banks have now been forced to bring onto their balance sheets. Examiners also overstated the quality of banks' assets, failing to allow for the potential bursting of the house price bubble."

However, I'm not entirely convinced of his contentions in these passages. For example, how are examiners supposed to 'allow for the potential bursting of the house price bubble?'

In hindsight, that sounds fine. However, up until said bursting, you can bet the banks in question would be screaming bloody murder and exercising whatever political influence they had, via Congress, to affect the examiners who were, at that point, baselessly criticizing still-performing assets.

As to the SIVs existing, that's another matter. But, even there, ultimately the banks took them back onto their balance sheets because they were obligated to provide funding when external markets dried up.

Who can say which housing loans should have been called into question prior to the beginning of the period during which funding for housing-related structured finance instruments or subprime mortgages ceased to come forward?

Other than making the general comment that growth in mortgage markets remained too high for too long, it's another matter entirely to be the Federal agency which unilaterally reins in credit expansion for those particular loans. What if various minority groups had, in that event, pressured the Fed and banks in question to continue lending, or suffer charges of discriminatory lending practices?

Aside from those last passages, however, I find Feldstein's analysis of the situation very much in concert with my own. We face a demand-pull threat of inflation, not the cost-push sources of prior eras. Money has already been relatively easy when the Fed began to cut rates last year. It's unlikely those lower rates have really sparked much new business activity or lending, because the greatest bar to credit expansion has been counterparty risk, not rate levels.

All of which reinforces my belief that the Fed's prior, and even near term future rate cuts won't materially affect our economy, other than bake in higher inflation rates 18-24 months out.

If this is true, precisely what has the Fed rate cutting program delivered to us as a benefit?

FedWatch For 11 December: Brian Wesbury's Views

As my partner and I discussed the potential effects of Tuesday's Fed rate decision on our impending options portfolio purchase, we turned to a discussion of Brian Wesbury's excellent editorial in Friday's Wall Street Journal, entitled, "Let's Not Panic and Ruin the World."

Demonstrating, once again, why he ranks at the top of my personally favored and trusted economists, Wesbury notes evidence of the US economy's continuing strength, and the lack of need for another Fed rate cut.

Among those signs are: real GDP growth, consumer price rises of 3.5% in the past year, positive recent consumer spending data, and the beginning of the credit market's self-healing, with purchases of or into distressed situations, such as Citigroup and E*Trade, by Abu Dhabi, Citadel, and CIFG's parent.

The primary ailment of the US financial markets at present is counterparty risk. That is, parties are worried about the soundness, or solvency, of counterparties which may hold assets, the value of which is overstated. These would include any assets involving subprime mortgages, e.g., CDOs.

It is not apparent that banks and other institutions are short of lendable funds. If that were true, rates would be higher. Rather, despite lower rates, certain problem areas are not receiving new loans. Such as the riskiest sorts of mortgages.

And, with Federal activity in the sector, and calls by various Presidential candidates for even more punitive actions, the long term market for investors who would buy mortgage-backed CDOs has to be evaporating.

As Wesbury points out, trying to "save the world" now will only put it at greater risk. What is really a problem for only a small part of on economic sector, subprime mortgage lending, is causing actions, including Fed over-easing, that may well damage the overall economy in the longer term.

Nobody wants to see the US fall victim to the type of liquidity trap which ailed Japan for almost a decade.

Hopefully, the Fed will hold the line on rates Tuesday, and surprise the market. By withholding the latest dose of economic narcotic from the markets, equity prices may temporarily decline. And fixed income rates will likely rise, decreasing prices of those assets, too, for a while. But to ease with another rate cut is to risk the beginning of yet another asset price bubble of the sort that the US markets saw peak in 1999 and 2007.

US employment, as we know from last week's jobs numbers, continues to grow. Personal earnings continue to grow, as does personal spending. The fundamental drivers of the economy, jobs and incomes, are solid and growing.

The US does not have an economy poised for recession. Rather, it has an overabundance of mediocre economists mistaking a single-sector credit problem for economy-wide weakness.

Fortunately, Mr. Wesbury continues to point us in the direction of sound data, correct interpretation, and preferred actions.

Or, as we hope this week, Fed inactions.

The Fed's Language & Pundits, Analysts and Investors

This week's Fed meeting had a noted and unexpected effect on the US equity markets. Due only to a change in language, not a rate change, the equity markets rose 1.71% on Wednesday.

The logic here is interesting. Essentially, the Fed has indicated that, although it does not currently feel the economy requires a rate cut to help avoid a recession, it is now leaning more toward a rate cut as its next move, than a rate hike.

Since equity market investors react to lower rates rationally, by bidding up prices, the market rose. This is fairly direct, simple economics, with a lot of historical evidence to back it up.

That day, CNBC aired some discussions of the Fed language and rate inaction among various pundits whom they frequently feature. One of those people is Doug Kass, a prominent, bearish hedge fund manager and senior partner at SeaBreeze partners. Kass argued that the rate cut bias now means the economic is in trouble, so equities should begin to experience price declines.

I wrote this post last June, discussing economists, analysts and pundits as they criticize Ben Bernanke and the Fed. It seems very relevant again now. There's only one Ben Bernanke, and one Board of Fed Governors. Doug Kass is not on that board.

Kass' comments provide a view to a strange sort of economic analysis and commentary that seems to be quite common these days. Secondary meanings and tortured behavioral implications gain credibility over the simpler, more direct analyses of various business and economic information.

In this case, the direct analysis is that the Fed is not overly worried about a recession. It simply indicated that it is prepared to move to reduce the probabilities of such an economic development. Rick Santelli, CNBC's excellent Chicago correspondent for interest rate products, noted, correctly, that the Fed will act when it needs to. Otherwise, its words are just that.

On the other side is Kass, and another, lesser CNBC light, economics correspondent Steve Leisman. They both contend that the secondary implication of the Fed's language is that there will be a recession, and the Fed will cut rates, and equity market indices will fall soon. Notice that this interpretation requires the assumption that the Fed cuts rate, but fails to prevent a recession. Two rather significant assumptions, indeed. From second-rate, non-Fed sources.

To many investors, all these opinions may be confusing, and seem equally probable. However, the net effect of investors' behaviors this week demonstrate that they are able to understand the primary implications of the Fed's language and inaction, and believe those.

For now, this is gratifying. With so many more B-team pundits and analysts than A-team counterparts, it's amazing the primary message can sometimes make it through all the noise at all.