The markets Monday were suffering their worst outing in two months, owing to a bleak economic forecast from the World Bank but also to the growing fear among investors that the various government stimulus and bailout programs have done little more than stave off an inevitable second economic collapse. Even some in the government are starting to admit that any recovery is not going to prove swift and strong.
As the Federal Reserve Board of Governors meet this week, they find themselves in a tenuous position. On the one hand, they must reassure the markets that they will do everything necessary to prop up the still-wounded economy. On the other, they have to talk tough on inflation, because, as we have seen in recent weeks, if investors see Jimmy Carter-level interest rates on the horizon, all growth, including that needed for recovery, stops. Forget stagflation, this time it could be stagnating recession, or worse, stagnant depression, which could be dubbed stression by wags.
Thus the Fed needs to talk tough while handling the economy with utmost tenderness. A very dicey position. Not to mention that it is printing money to spur the economy while propping up the spendthrift government by purchasing some $163 billion (so far, of $300 billion planned) in Treasurys. At what point does that become a shell game?
Sooner or later, interest rates must rise. The question now is when. It was artificially low interest rates promulgated by the Fed after 9/11 that fueled the housing boom, bubble and bust. No question the policy was correct for the time, but in retrospect lingered longer than it should have. This time, a similar mistake could yield the feared "double-dip."
Low mortgage rates have without question helped put some sense of stability into the housing market, but they have failed to stimulate demand in other than low-end, first-time-buyer segments, which have been driven by tax credits and speculation on foreclosures. That market segment alone can not lead housing , or the economy, to recovery. The Fed, indeed the government in general, needs to restore the wealth that has been lost by productive, taxpaying citizens by cutting spending, strengthening the dollar and promulgating business growth. Unfortunately, that is not what they have been doing.
The conventional wisdom is that the Fed will not touch its key rates at its meeting this week, keeping them pretty much as low as they go. But it may become necessary to let rates rise sooner than later. If the Fed doesn't do it, investors (a.k.a. China) will.
Clearly, the Fed is on the spot.
