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Wednesday, August 15, 2007


rate cuts may actually be difficult to justify going forward

it's commonly presumed -- particularly lately -- that the federal reserve can "fix" the mess of the markets by cutting the fed funds rate. and they certainly can reduce the rate anytime they want, making money cheaper to borrow.

but there are a number of difficulties with such a simple scenario. one is the insolvency problem -- slightly cheaper financing is not the end-all for enterprises and people facing more debts than assets. banks may not be compelled to mark their damaged illiquid assets -- japanese banks held assets above their market value for years in the aftermath of their asset price collapse in 1994 -- but finding further leverage will be very difficult.

another is that the fed's mandate is not ot save markets but to provide price stability. in practice, with a burgeoning fiat currency, this means keeping a cap on the inflation statistics manufactured by the government for public consumption.

that's about to get more difficult, as two major negative cpi months roll out of the backward 12-month window. the fed's justification for rate cuts being inflation fighting and not money supply or liquidity concerns, this will make it very difficult for the fed to cut -- and indeed, from their current tightening bias, may even pressure them to raise rates.

this is exactly the opposite of what the fed funds futures are telegraphing, and disappointment could take the form of selling pressure as economic conditions weaken.

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