Coming Full Circle

Is it just me or does anyone else find it somewhat ironic, that one of the most often sighted reasons for the current predicament we now inhabit, namely that interest rates were held too low for too long by the Greenspan Federal Reserve, is apparently one of the cures.

The cheap money policies of the Federal Reserve that led directly to the biggest housing bubble in history and an acceleration of an even bigger debt bubble, is now the one the answers for how to fix it. Inquiring minds may wish to ask why the US government's brightest think this is the right path to take.

Quite simply the answer is that they don't know anything else, the Federal Reserve is the proverbial one trick pony. They encourage speculative bubbles on the way up and then rather than let them deflate of their own accord, try to reflate them on the way down.

This asymetric approach to monetary policy is a key reason why the US stockmarket is now lower than it was 10 years ago. Instead having a proper recession in 2001 and letting asset prices correct to realistic levels the Fed propped it up with cheap money.

That may seem to be a strange statement in light of the fact that the S&P500 declining -49%, but that was after the ridicuous prices of the dotcom bubble. That meant that the ensuing bullmarket that kicked off in 2003 started at the highest market P/E ratio in history.

The corporate profits that drove stock prices were underpinned by an unsustainable low cost of capital causing unsustainably high profit margins. What you are seeing now is a steady reversion to the mean. However, once again the one trick ponies at the Federal Reserve are doing their best to prevent that from happening.

Will it work? David Callaway of marketwatch.com suggests it won't and I think he may be on to something.

Arguably, it was a dramatic easing of interest rates after the tech bubble collapsed that plunked us into the systemic soup in the first place, allowing people to take out mortgages at ridiculous rates and Wall Street to make a killing by packaging the mortgages and playing various rates off each other. But it won't work this time around. Nobody's lending, and nobody is borrowing.

Since the current consensus is that financial armageddon and the great depression markII has been avoided, attention has turned to how bad the current recession will be and how bad are corporate profits are going to feel the pinch. There mainstream is that the 4Q08 will be the trough of the recession and that the US economy will be on the road to recovery in the second half of 2009.

Since the consensus never saw the current crisis coming, never saw a stockmarket decline or a corporate profits recession, I feel comfortable in betting that the consensus will be proved wrong again.