Thursday, March 10, 2011

Fed Goldilocks Ignites Firestorm, Three Bears Now Homeless

Under the guise of engineering a "Goldilocks" recovery, the Federal Reserve has instead heated up yet another bubble which is now imploding.

The Fed has long played Goldilocks to the U.S. economy, claiming the ability to avoid overheating ("too hot") or contraction ("too cold") and thus engineer a "Goldilocks, not too hot, not too cold" economy. Let's look at a long-term chart of the S&P 500 to see how successfully the Fed's Goldilocks has achieved a steady-state of merely "warm."

Things swung from mighty hot to mighty cold and then back to boiling from about 1995 on. This chart shows that the Fed's claim to Goldilocks powers is pure hubris: what the Fed excels at is not maintaining a "warm" economy of steady employment and low inflation but a bubble economy of rampant speculation that inflates huge asset bubbles which then boil over and take down the real economy, which quickly chills to contraction and recession.

In its hubris-soaked over-confidence with matches and the gasoline of credit creation and market intervention, the Fed has cranked up the heat and lit a conflagration which is burning down the three bears' home and indeed the entire global economy. Exhibit B: a chart of the NASDAQ:

The Fed got cocky in the late 90s bubble and once again in the Travesty of a Mockery of a Sham 2003-2007 "Rally." It certainly seemed to those adjusting the flame that constant manipulation of the credit markets and cloaked intervention in the equities markets could be extended forever.

But heating up credit, leverage and risk bubbles only offers a facsimile of "warm."The more apt analogy is a pressure-cooker set on a burner cranked to high heat. Eventually the pot explodes.

There's a funny little thing the Fed thought itself above: unintended consequences.By cranking up easy credit and zero interest rates, then you loose the dogs of speculation, not wise investment. (Duh!) By lighting the fire of speculation in the housing market and inviting everyone to join in the bonfire, from people with no capital at all (love those no-doc loans, baby!) to those with the craftiness to originate "risk-free" mortgage backed securities via the legerdemaine of embezzlement, misrepresentation of risk and fraud, the Fed created a bonfire of extreme vanities.

Quelle suprise, another bubble is conjured up and then implodes. (Why oh why couldn't it expand into the stratosphere and then head for the moon?) Only the housing bubble was different: unlike stocks, housing was the bedrock asset of two-thirds of the nation. It wasn't just a $5,000 IRA account which blew up, as in the 2000-02 stock meltdown: it was the core of their lifetime assets.

Supremely confident (or was it just supremely desperate?), the Fed cranked the burners up to high in 2008 and then started a roaring fire in the fireplace with its massive QE1 and QE2 interventions. Having learned nothing from the firestorm created by its last credit-speculative bubble, the Fed once again pumped trillions of dollars into the wrong hands, encouraging rampant speculation and abuse of credit in all the wrong places. The result is: the current "overheating" bubble is popping.

The big fat classic wedge that stocks traced out has now broken down. Feast your eyes on these charts:

It's a cycle that the Central State and its proxies cannot abandon. Keynesian intervention was supposed to work only in key moments of massive credit contraction. (It took a global war in 1941 to "prove" the value of that proposition.) But the political pain suffered by politicos during the necessary ebb tides of capitalism was too much to bear, so the Central State sought to "fine-tune" the economy continuously with ever larger applications of fuel.

By the time the Fed moved to straight gasoline, nobody in the Central State even batted an eye: whatever it takes to create the illusion of "growth" was fine with scared politicos.

So now Goldilocks has burned down the house and the three bears are homeless.Who can blame them for wanting to evict Goldilocks and take away her matches and gasoline?

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