As the usual suspects chorus with irresponsibly politicized Republicans and intellectually invincible academics on the urgent consensus in favor of monetary stimulus — the Fed Funds market probabilities for the Fed’s January 30 decision stand as follows:
Probability of 50bp cut in the Fed funds rate: 42 percent
Probability of 75bp cut in the Fed funds rate: 40 percent
Probability of 100bp cut in the funds rate: 17 percent
(Probability of 25bp cut in the funds rate: 1 percent)
On Friday afternoon, there was a truly nightmarish rumor ricocheting around: that Ambac was securing some kind of government bailout of the bond insurance industry. After Ambac’s 52 percent Thursday plunge, it was up 20 percent throughout most of Friday, but at the end, it nosedived, presumably smothering the bailout rumor.
If the government will step in and bail the financial sector out–ok, I take that back because it already has thrown hundreds of billions at the mortgage brokers and the banks off-balance-sheet, at the expense of the US dollar–then the monoline sector is the obvious weak link in the dam. Buffett has already started his own monoline, Berkshire Assurance, but he will not make any big moves until at least one of the monolines actually files for bankruptcy and unleashes the final round of (credit-deflationary) chaos onto the financial system. That will mean tens of billions more writedowns for institutions all over the country (especially if Buffett waits until MBIA blows up, as well as Ambac).
At that point the game theory for the financial elites gets very interesting. Once Ambac dies, will MBIA be able to secure heavy hedge-fund or SWF financing at the height of the panic? Will it die and subsequently trigger a massive government intervention? Or will Bernanke et al. just let MBIA die and let capitalism solve its own problem? Buffett wants to dive in at the height of panic, but if the federal government gets too panicky and pre-empts him, he loses. The current crowd has been choking the credit markets with new paper for the past six months, and has exhibited pure panic.
At the same time Buffett knows that there are very few people alive with his combination of knowledge of the monoline sector, his real AAA credit rating, and his pile of ready cash. So a lot of potentially flush speculators would be extremely leery of jumping into the business before Buffett does. The previous iteration of bulls who rode into Citigroup and the monolines in November are bankrupt or horribly burned.
If we did not have so much panic-driven bureaucratic power to deal with — the Treasury, the Fed, Congress, and the White House, in that order — the markets would be operating much more efficiently. There would be no chance of a government bailout, so the monolines would have thrown in the towel in November. Banks’ credit portfolios wouldn’t have the Fed’s paper crutch to lean on, so they would have fire-sold their credit portfolios to the Buffetts and Citadels who had waited out the most frenzied chapter of the bull market for the opportunity.
Instead of focusing on actual economic activity, we must parse every grammatical construct of our born-again-inflationist high priests to see how and if they will continue to thwart market efficiency, by printing more forms of paper to “erase” old debts and subsidize bad habits.
Undergirding all this policy machinery is a pernicious “establishment consensus” that deflation is some kind of terror that must be stopped at all costs.
Sure, “deflation is bad,” in a vacuum. But what are the alternatives to deflation? Deflation means a massive slowdown in consumer spending. Which, in a vacuum, “is bad.” But we’re not in a vacuum. American borrowing has reached absolutely unprecedented levels. Deflation is the market’s cure for a low aggregate savings rate. It forces debts to be fire-sold in the near term, and in the longer term, it brings down formerly inflated asset prices into the reach of more people. Deflation is a price phenomenon as well as a debt and wage phenomenon, remember…
More inflationist decisions by institutional elites now mean more deflation later.
It is one thing for the government to intervene in financial markets to offset an exogenous shock, such as 9/11. There is no rationale for the government’s intervening against an endogenous financial shock.
Deflation is a short-term consumption killer, but a long-term shot in the arm for the savings rate. It’s not “evil.” Saying “Inflation is bad” is like saying, “Vomiting is bad.” Vomiting is unpleasant, but if you have had too much to drink, vomiting is very good for you.
Unfortunately, commanding-height institutions have a way of never admitting they’re wrong. If history is any guide, the “credit crunches” will continue, with sporadic Fed helicopter-scrambling to temporarily “calm credit fears,” until the dreaded wage-price spiral kicks in to overcompensate for five years’ soaring energy, food, healthcare, and education prices which the Fed has willfully ignored.
Why is anyone surprised that Americans don’t save, when government’s pain-averse, inflationistic ideology is what it is?
Right now, we have credit deflation occurring alongside consumer price and commodity inflation. The Fed is entirely focused on the former, but popular inflation expectations are moored to the latter. The Fed has “greater” priorities than price stability or dollar credibility.
Market manipulations can work if they’re very short-lived. I have seen just a few with my own eyes. But long-run attempts at market manipulation always fail.