Can the Fed and other central banks shape economic conditions and induce stock market rallies? Lots of people seem to think they can, believing the surprise 75-point cuts in the Fed funds (from 4.25% to 3%) and discount rates Tuesday will help the economy avert a recession and lift stocks out of their recent funk. Others see the latest Fed interest rate cut as an ominious sign that “Hey, things are really bad,” especially since it came a week before a regularly scheduled Federal Open Market Committee meeting.
So far, the Fed and central banks have thrown a lot of ammunition at the unfolding economic problems sparked by the downturn in housing: (1) Injecting large amounts of money into the banking system to provide credit liquidty and pushing banks into making loans they might not want to make, (2) cutting Fed funds rates four times since September including Tuesday’s big reduction, with another possible 50-point cut at next week’s FOMC meeting and (3) developing a “stimulus package” that President Bush will probably reveal in his state of the union message.
My take: (1) Throwing money into the system seems to me to be inflationary, the exact issue the Fed has been trying to battle, and debts are just being pushed from one pocket to another. (2) Is the interest rate weapon a six-shooter — what do we do when we run out of those bullets? (3) Short-term fixes may be good for temporary relief (questionable in the current situation) but just slide dealing with the real problem back and, most likely, making the problem progressively worse.
What do the Fed or Administration have left to manipulate the economy away from a recession? In the mid-1970s when oil prices rose sharply, commodity prices hit record highs, the stock market tumbled — any of this sound familar? — the wise thinkers of government came up with wage and price controls. That led to shortages, long lines at gas pumps and other nightmares, and it didn’t do much for the stock market either. One can only hope today’s leaders don’t try to repeat that mistake.
The Fed and the government tend to follow the market and come up with reactive “solutions” they hope will work but are short on proactive answers. Instead, they seem to interfere with natural economic cycles and ultimately make conditions worse than they might have been. It is amazing to me that bankers, who should be the smartest people, do some of the stupidest things (how could they forget the savings and loan debacle a generation ago?) and that someone will package their mistakes so that the burden is shifted onto the public.
In any case, it looks like the R word is here now and that it will be a rocky time for many markets.