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Wednesday, June 25, 2008

The Fed's Inflation Two Step

Ben Bernanke announced today that he was halting his rate cuts and keeping the Fed Funds Rate at 2%

The Federal Open Market Committee left interest rates alone Wednesday, choosing not to lower rates further to help jumpstart a slowing economy or raise them to ward off inflation.

The decision to keep the federal funds rate -- the rate banks charge each other -- at 2% was widely expected on Wall Street.

The Fed has recently indicated that an increasing fear of inflation is the cause of their change in stance. Yet, as I have been saying over and over it is the Fed's own action that is causing all this inflationary pressure. In fact, the Fed, by lowering rates dramatically, has put even more pressure on an already weak dollar. This, in turn, put more upward pressure on oil and most other commodities. It is energy and food that is leading the way on the overall inflationary pressure.

Furthermore, the Fed was looking to add liquidity to the credit markets in order to alleviate the mortgage crisis. As such the Fed Funds rate was dropped from 5.5% to 2%. It is very unclear what if any impact this aggressive move did to alleviate the situation. In fact, the Dodd/Frank bill is a government sponsored Boondoggle that, among other things, will add much needed liquidity to the credit market. If the Fed had succeeded in its course, the corrupt Dodd/Frank bill would have been unnecessary.

More and more, it appears to me that recent history is repeating itself. Back in 2001, Alan Greenspan began lowering rates in an attempt to stimulate the economy. The economy also took fiscal stimulation too, when the Congress and the President passed the Bush tax cuts. In that case, those aggressive rate cuts unwittingly lead directly to the mortgage crisis. In this case, more aggressive rate cuts also appear to be ineffective. It appears that it will again take fiscal stimulus to move the market. Again, it may take fiscal action to provide the stimulus that Fed action was supposed to provide. More troubling, Fed action is again having the unintended consequence of perpetuating other economic problems.

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