Fed

What will the fed do this week? probably lower rates. What should the Fed do? harder to say. Great editorial in the Journal this weekend talking about the Fed repeating the mistakes of the 1970's (being more worried about growth than inflation). Are they right? Is the Fed more worried about recession than inflation? probably -- take a look at the price of gold -- its almost at new highs. History time:

1970's we had about 4 recessions from 1969 to 1982 or about 1 every 3 years with the last one in 1982 being the worst since the depression. Stagflation was the term to describe the 1970's because we had periods where the economy was not growing or barely growing and yet inflation was reaching high single to low double digits? That wasn't possible according to the Keynesian view of the world (uh.... maybe Keynes has always been wrong about pretty much everything!) but it was basically caused by a combination of an ineffective and incompetent Fed as well as too high taxes and too many regulations.

Volcker comes in and tries to eliminate inflation and doesn't let up even though the economy gets crushed. He finally relents and then Reagan cuts taxes and continues to deregulate the economy (Carter actually started it by eliminating the Civil Aeronautics Board that set airline prices) and the combination eliminates the inflation and gets the economy growing -- this unleashes the last 25 year boom.

Greenspan takes over a few months prior to the Crash of 87. His response to the crash? add liquidity. Next tax reform hurts real estate investing plus partial dereg and the collapse of the junk bond market threaten savings and loans -- much much worse than today's issues in terms of the banking system. Combine this with tax increases a la Bush as well as higher rates from the G-man and you get a recession. What is Greenspan's response? cut fed funds to 3% -- lower than it had been in quite a while. In 1994, he raises and almost causes the next recession but he relents in late 94 when the GOP wins the congress and Mexico blows up. Strong economy until Asian issue starts in 97 and then the Russian default and LTCM in 1998 -- what does G-man do? cuts rates 3 times in the fall. Nasdaq explodes higher. He raises rates in 2000 then comes tech collapse. Response? cut rates to 1% to avoid deflation and keeps them there for 1 year and then raises them very slowly. Response? huge debt boom in real estate -- and LBO's.

Just to recap -- in early 90's real estate was ugly -- especially commercial real estate. Fed funds cuts dont' really help real estate but they do start up a boom in technology spending helped by the advent of windows, networking and other technologies. By 2001, tech has collapsed after a huge boom but by now real estate hasn't done much in 10 years so all the new liquidity goes there -- not to mention into commodities like energy (thanks to oil's 20 years in the wilderness of no cap ex spending causing supply to finally reach shortages once China's growth kicks in). Several years later the real estate boom collapses but by now technology has finally moved back into shortages. Meanwhile China continues to keep the commodity boom going.

So it sure appears that the fed's mismangement under Greenspan has caused the economy to alternate booms/busts between technology and real estate. Right now we appear to be starting another tech boom. Fed cuts won't save mortgages but will help Tech. Will we have a recession? don't know but for the next 6 months the answer is no. As liquidity is used to push out a recession -- a normal cleansing process -- there is a theory that the imbalances aren't allowed to clear and that they just keep building until one day the economy will suffer the worst recession since the depression again. Its possible but I like to think of the last 25 years as not too many general overall recessions but a lot of rolling industry recessions/cycles. So maybe all those excesses do clear its just a few industries at a time.

have a good week