Sunday, August 12, 2007


WSJ recognizes the credit bubble and its consequences

Good for them, although it is a bit late in the game to lose faith in the Goldilocks economy.

It's worth recalling in this connection that the root cause of this credit correction was the Federal Reserve's willingness to keep money too easy for too long. The federal funds rate was probably negative in real terms for close to two years between 2003 and 2005. This led to a misallocation of capital into real estate and certain mortgage instruments that is currently being worked off. For the Fed to take its eye off the price-stability ball now in response to short-term market gyrations would only compound the original policy mistake.

Now if we could only convince Larry Kudlow. Nah, there is no chance of that. The problem is that we are so far into this bubble that the pain of its deflation will be far worse than an earlier call for fiscal rectitude would have been in say... 1997 or '98. For the Fed to sit out at this point and let nature take its course will produce a huge amount of suffering which might be avoided with a little taste of the easy money. I am not talking about slashing rates to the create another bubble but we should realize that doing nothing is a recipe for a horrific crash and depression.

For this reason, and because Ben Bernanke has studied the Great Depression, the Fed will ease when the markets really start to melt down. Then we will know that it is too late to act. But don't try and talk the Fed out of its only hope to mitigate the disaster they created.

P.S. There are enough indicators showing the market oversold that I would not be surprised to see a bounce or sideways trading early this week. We will see how far this takes us before I can say the bear has resumed.

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