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More on the Fed’s free money policy

An interesting piece by Lauren Tara LaCapra at The Street.com digs a little deeper into the consequences of pushing interest rates so low. The big fear is that we “turn Japanese” and interest rates in the zero range do no good. This part near the end struck me:

Some predict that, in light of the heady reward potential, investors will once again warm to equities and private debt. When that time comes, the current trends are certainly setting up a massive opportunity for those who manage to jump in at the right moment to reweight holdings just before yields and prices reverse. But, of course, bottom-seekers bet wrong much of the time, and there’s no telling what might happen in the intervening months.

For now, investors are willing to settle for paltry returns on safe government debt, much more of which will be issued in the coming year to fund Uncle Sam’s costly plans to shore up the economy.

“You never want to stand in front of the Fed. They’re going to be successful in what they’re doing,” says Paul Mendelsohn, chief investment officer with Windham Financial Markets. “It’s not going to happen overnight, and it’s going to be a little more painful than people think it’s going to be, but it’s going to happen. The question is what’s going to happen after that.”

Indeed. Sending interest rates too low after the dot-com crash caused the housing bubble that got us into the much deeper doo-doo we’re in today.

Some people fear hyperinflation from all this money raging from the Fed’s spigot, but this piece notes that deflation is far worse.

A lot of inflation is bad, but a little is healthy because it encourages people to buy now in fear of higher prices down the road. Even a little deflation is scarier because it encourages people to sit on their cash and wait for lower prices down the road (kinda like what happens to the stock market after it’s just lost 40 percent of its value or the houses in your neighborhood are all down by a third).

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Tom Mangan posted at 12:26 am December 18th, 2008 |

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