Death is NOT the Worst of Evils

The following is a re-print from an e-mail I received from NewsMax.

Fed Mounts Up To Face Calamity of Three Dragons

As Bloomberg observed today, Federal Reserve policy makers, who
declared inflation was their paramount challenge just two weeks ago,
have been forced to make financial market stability the trigger for
changes in interest rates.

Fed Governor William Poole recently said only a "calamity" would
force the Fed to make an unscheduled change in policy.

But, as Telegraph writer Ambrose Evans-Pritchard points out, “…
do we now face calamity, or was Mr. Poole being flippant?”

Last Friday, Telegraph writer David Litterick observed from New
York, “Yet as shares continue to plummet; it became clear that those
dollars were not finding their way to the people and institutions
that needed them most.”

How very hollow the assurance of less than two weeks ago by our
President, our Treasury Secretary, and our Fed Chairman now sound.

So, it appears that our Fed faces not just the single sleeping
dragon of stealth inflation, but also the dragons of deep recession
and of a seized-up credit market. Worse still, two dragons appear to
be getting to their feet, pawing the ground and snorting flames in a
decidedly fearsome manner!

Poor Ben Bernanke! It appears that his armor (the economy) is
rusty and his lance (the flexibility of positive “real” interest
rates) is decidedly short and feeble. In addition, it appears that
his normally trusty steed (political backing) is extremely worried
at the sight of the dragons and is taking nervous backward steps,
towards the security of the stables!

We believe the mother of these three fearsome dragons is what we
have often described as the “Great Inflation Lie”.

As our readers will know, we have long described how our
Department of Labor has — by “cooking” the data according to the
Clintonian recipe — long kidded us that our inflation rate is a
farcical 2 percent!

Although we all know it must be far higher, our interest rates
have been “politically” set based upon this false inflation rate.

Alternative Government Statistics, calculating on the Pre-Clinton
basis, show our inflation rate to be at least 6 percent — three
times what our government says it is!

An inflation rate of 6 percent and a Fed funds rate of just 5.25
percent represent a negative “real rate” of 0.75 percent.

So banks, which can borrow from our Fed at minus 0.75 percent,
were in clover.

Now all our readers can see exactly why the incredible boom in
asset prices took off. Imprudence, greed, and financial recklessness
were richly rewarded.

On a diet of “give away” money, our banks lent like there was no
tomorrow. They then off-loaded their imprudent loans in the
highly-leveraged derivatives market to greed-motivated hedge funds
and other reckless investors, some of whom did not know what they
were buying.

So the whole crazy asset boom that we are now seeing unwind in a
chaotic manner, was fueled by our very own Fed.

To be fair, poor Ben Bernanke inherited the Great Inflation Lie.
Doubtless, he saw it, but he lacked the political backing to expose
it.

He was in the position of a general who suddenly announced that
we had attacked Iraq both illegally and with insufficient force to
ensure a victory. He would have been fired, with a greatly reduced
pension.

We believe this explains precisely why our Fed has consistently
maintained that inflation was their main concern. But they were
afraid to act.

The result of this is that interest rates did not rise, as we
have long urged, to reflect a healthy, positive “real” rate.

The appalling drop of our U.S. dollar in the foreign exchange
markets shows that we were not alone in seeing this stealth
inflation (The First Dragon).

We long predicted a collapse in the asset boom, particularly in
subprime mortgages and that this would lead to a very serious credit
crunch (The Second Dragon).

In July, we saw real signs that our economy was heading toward
recession (The Third Dragon).

We believe that Bernanke is no fool and that our Fed could see
these three dragons — all still asleep at the time, but roaring!

Then the subprime debacle (in what the Telegraph describes as
“the worst housing slump since the Depression”) kicked the second
dragon somewhat rudely. The credit dragon awoke in great anger,
snorting fire. In a rapid flight to safety (Treasuries) the credit
markets froze in fear of lending.

Two trillion dollars of subprime and Alt-A debt still lay as
“toxic” waste in a food store. All the produce is tainted. No one
wanted to enter the store, even to buy other goods.

Our knight (The Fed) remained frozen in fear, but mouthed strong
words against the first dragon (inflation), as it reassured us that
it was not concerned about the remaining two dragons.

Then our Fed decided to take action against the credit dragon,
but not firm action — just a flash of its sword and words of
aggression.

In our view, the Fed is genuinely and with good cause afraid to
lower the Fed funds rate (at which it lends to the banks within the
Federal Reserve System). However, a lowering of the Fed rate would
make interest rates even more negative, spurring more inflation, yet
further eroding our dollar.

The Fed has real and understandable fears about lowering the Fed
rate. So it lowered the Fed discount rate (at which banks trade
funds in the inter-bank market).

This has re-established some, possibly short-term, confidence in
the inter-bank market.

Under normal circumstances this confidence could be expected to
flow through to commercial and retail lending.

But these are NOT normal times.

Our economy is weakening. “Toxic waste” permeates our lending
system and stealth inflation lurks.

Our banks are understandably “shell-shocked” and afraid to lend.

As we have said, by merely supplying liquidity, the Fed is
pushing on a string.

So, as the Telegraph says, the funds are not getting to those who
need them, small businesses and homeowners.

Home Equity Loans are largely geared to the prime rate.

Adjustable rate mortgages (ARMs) are mostly geared to LIBOR (the
London Inter-bank Offered Rate for Eurodollars — U.S. dollars in the
hands of non-American residents.) LIBOR is not tied to — but is
heavily influenced by — the U.S. Fed rate. Unlike the Fed rate,
LIBOR floats with market demand.

So, until the Fed lowers the Fed rate, no meaningful financial
relief will be experienced by American consumers, most of whom have
mortgages and are the key to our economic growth (comprising some 70
percent of GDP).

Long-term fixed mortgage rates are computed by the lenders on a
series of “in-house” formulae. We are told that long-term Treasury
yields are key components.

One further important problem facing the Fed is that any
reduction of the Fed funds rate will be seen by the Treasury market
as inflationary, forcing long-term yields upward.

So, thanks to the politically motivated, “Great Inflation Lie,”
our Fed has been put in the most difficult of all positions, with
very little flexibility.

In other words, due to its past weakness in raising rates, the
Fed does not start with the flexibility offered by a strong dollar
and healthy real interest rates.

Meanwhile, our politicians offer little constructive advice or
worthwhile assurance. Instead, they appear to be concentrating upon
closing the door now that the horse has bolted, by blaming the Fed
(not the Labor Department, who issue the false inflation figures)
for allowing the boom in aggressive lending to take place, according
to our free enterprise system.

Talk about the pot calling the kettle black!

Although, in the past, we have criticized the Fed for not raising
rates to reflect the “real” rate of stealth inflation, we feel great
sympathy with their present position.

We believe that only one of our figurative dragons can be killed
at a time. They must be killed in order of their danger and
alertness.

We think the Fed has gone correctly for the third dragon
(credit). Without credit markets our economy is sure to stall, big
time. So this is the first priority.

But killing this most fearsome of all our dragons will not be
achieved by flashing a sword (discount rate) and shouting. It will
require the lance of cutting the Fed funds rate, and fast, before
the second dragon (deep recession) awakens.

Unlike many cheerleaders, we can already feel the hot flames from
the second dragon (the economy) and urge the Fed to lower the Fed
funds rate, quickly, despite the risks.

The first dragon (stealth inflation) is still asleep. Despite its
danger, it must be left until the other two are dealt with.

As far as the stock market is concerned, our readers should look
to economic trends and not be sucked in by rate cuts.