Bernanke is Missing Something

The Federal Reserve sliced the Federal Funds rate by 50 bps to 4.75% and the Fed's overnight bank lending rate by 50 bps to 5.25% (the latter move follows a previous move of 50 bps).

In doing so, the Fed stimulated the stock market to surge higher, the dollar to surge lower (also, presumably good for the US economy) and volatility indexes to fall. Hooray!

But, Bernanke unfortunately showed that he is willing to ingore reality and cave in to the vocal demands of a mortgage brokers and hedge funds that rode the mortgage boom too long and needed to be bailed out.

Here is why he was mistaken to cut:

1) There is no recession. The economy is strong. Aside from one weak and questionable jobs report two weeks ago, we have had no material indications of a recession.

2) Inflation, which has been Ben’s primary concern, has not gone away no matter what indicators the Fed is conveniently choosing to look at. If anything, oil prices (over $81 a barrel) are likely to continue to act as a significant tax on the economy, especially if left unchecked.

3) Moreover, by adjusting monetary policy, Bernanke is increasing liquidity, but the underlying crisis is not a liquidity crisis; rather, it is a credit crisis brought on by too much liquidity. Bernanke is arguably therefore only allowing the factors which contributed to the current problems to rearise, rather then for the current problem to sort itself out through natural free market forces.

Today's rally will quickly evaporate. Today's problems are long-term and without quick fixes. In the next year, credit problems will re-emerge, the real estate market will continue to fall dramatically, inflation will become more significant and September 18 will be recorded as the day when Bernanke proved himself impotent.