Caution: Fed oversteering ahead

The Federal Reserve continues to signal its intention to maintain a highly accommodative stance of "exceptionally low levels of the federal funds rate for an extended period," while acknowledging that "the prices of energy and other commodities have risen of late" (see full FOMC statement here).

The editors of the opinion pages of the Wall Street Journal voiced their concern over the Fed's continued extreme accommodation in a piece today entitled "No Exit: the Fed keeps the accelerator floored." The editors advised, "It's a lot safer to slow down gradually than have to screech to a halt to avoid another asset bubble."

Similarly, economist Larry Kudlow today penned a blog post entitled "Have we seen this Fed movie before?" In it, he asks, "Is the Fed repeating the very same easy-money mistake it made between 2002 and 2005, when it totally bubbled-up and inflated housing, energy, and financial markets, all of which led to a 6 percent inflation rate down the road? Of course, all of that also led to a very deep recession."

The problem both articles are addressing is a very grave problem, and one we have addressed before. It is the modern phenomenon that we call "Fed oversteering," which we addressed last month in a post entitled "The Fed's oversteering and the wreckage of the past decade" and one we would recommend re-reading this week.

The Fed initiated their current near-zero funds rate policy in the depths of the financial panic that was largely caused by the deflation of the last Fed-induced bubble. The very real danger is that the Fed's excessively easy stance will lead to another bubble, that the Fed will eventually move to choke off -- possibly wiping out valid businesses in the process (just as valid businesses were wiped out -- or at best dealt a staggering blow -- when the Fed tightened severely in response to the dot-com bubble in 2000).

This kind of volatile Fed policy is something that businesses -- and investors in those businesses -- should not have to deal with. However, it appears to be part of the landscape for the foreseeable future.

Investors can print out the above "caution" sign and pin it above their desks in order to remind themselves to be alert for the inevitable repercussions of the Fed's oversteering.

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For later posts dealing with this same subject, see also:


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