Tuesday, September 18, 2007

A Cake Not A Soufflé

Re the subject of the day, everyone has an opinion so here’s mine: Fed cuts Fed Funds rate ¼ point, cuts the discount rate cut by a ½ point. That, or some version of it, is what is baked into the cake. What is not in the ingredients is a little something extra that the Fed might stir into the mix, perhaps re the terms for loans at the discount window or some other creative, unforeseen way to ease the credit risk pressure. And this may make today’s decision and accompanying language that much more interesting and informative.

Clearly, the Fed’s task goes far beyond what will appease investors. It must strike the balance between a US economic slowdown morphing into a recession and solid global growth with still considerable levels of excess money creation. For example, according to the IMF, the BRIC countries' money supply growth ranges from the upper teens (India) to over 50% (Russia). And when you include the money created by the financial innovation wizards of Wall Street, an abundance of dough is still sloshing around the world.

All this excess liquidity (along with strong global growth) points to the lingering and potentially growing risk of global inflationary pressures in the midst of a US economic slowdown/recession. For the US, this is stagflation on a global scale. And definitely unmanageable by any one central bank (with domestic considerations at the top of its to do list).

Therefore, if the Fed can continue to find the right mixture and progress in appropriate steps and if the market discipline is allowed to continue to do its part, the world’s markets might be able to work their way out of the current mess. The alternative (global stagflation) is unacceptable, let alone highly dangerous.

The Fed wants a cake, not a soufflé.

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