Friday, August 22, 2008

The Curious Beliefs On Current Monetary Policy: A Depression Warning

As we pointed out below, Fed chairman Bernanke believes the Fed is currently conducting an easy money policy.This despite the fact that as recently as Mar.2008 three month annualized money growth (M2) was climbing at annualized rate of 12.6%, but has since collapsed to the point where as of Aug. 21 three month annualized money growth (M2) is increasing at only a 2.5% annualized rate.

This is simply a remarkable drop in money growth that will lead to a depression, if not reversed.

It can be argued that a halt to money growth pyrotechnics is a good thing, and we would concur that the end to money supply manipulations by the central bank can be a positive if it is adopted as a long term attempt at stable monetary policy. However, the clueless nature of the current slowdown in money growth could lead to a depression whereby radical government policies are adopted to "cure" the recession. Such new polices are apt to further stifle the economy and prolong any downturn by years.

Thus, Bernanke's misunderstanding of current money supply policy is shocking. More shocking is that many other economists, if not most, hold this inaccurate belief. In today's WSJ, economist Gerald O'Driscoll warns of potential inflation and writes that "Now Fed Chairman Ben Bernanke has decided to try to... spend the Fed's reputational capital on an easy credit policy."

They hold this inaccurate belief because interest rates are low. Generally, such low rates would result in huge money increases. However, if real interest rates are lower than fed fund rates, which appears to be the current case for no-risk government securities, money growth will not occur.

If this policy is not soon reversed, we repeat, we are headed for a depression. It will make the current housing crisis look like boom times.

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