The Fed Cut Rates – But How Low Will They Go?

The big news yesterday: the Fed cut rates to 1%. Only 100 basis points left to go, in other words.

Yes, dear reader, the Fed's key lending rate will probably go all the way down to zero. And the Dow will probably go to 5,000.

Sooner or later, the dollar will collapse too. We saw a hint of it yesterday...when the buck dropped back to $1.29 per euro.

This morning, Asian stocks are "soaring" on the news of the Fed cut. Predictably, investors think the feds finally might have this thing under control. Predictably, they are wrong.

You'll recall that the credit crisis began in the summer of '07. Before that the 'war' between inflation and deflation had been an even match. But then, sub-prime debt came upon the battlefield like a new tank. In a matter of days, deflation seized the high ground and has been winning ever since.

Of course, you have to give the feds credit. They've fought a good fight. First, in England, they bailed out Northern Rock and later nationalized the whole banking system, guaranteeing practically all deposits. In the United States, they abandoned Bear Stearns to the enemy, but they took over Fannie and Freddie...and rescued AIG, when Hank Paulson realized that his firm, Goldman, had $20 billion at risk. Then, they handed out over $100 billion in "tax rebate" checks. When that didn't seem to do the job, they passed a $700 billion bailout bill - in which Paulson will buy up his old crony's mistakes. And now they are talking about another general rescue effort at a cost of a few hundred billion more.

The Fed, meanwhile, has been doing its part to support the war against free markets. They've cut rates, of course. They've also traded their good credits for Wall Street's bad ones. That is, the Fed's balance sheet used to show billions in U.S. Treasury bonds...and little else. Now, the Federal Reserve has one of largest stockpiles of financial roadkill in the world...and only 100 basis points of ammunition left!

None of the measures taken so far seems to have done the trick. The cutbacks continue...in fact, they are just beginning.

"No more travel," said one corporate directive we saw yesterday.

"Cut out all training," said another. "We're not hiring anyone new and if the others don't know their jobs by now, get rid of them."

"Stop printing things...just send them out by Internet," was yet another cost cutting measure.

And soon, the printing presses will be silent...the pulp mills will slow down...and there will be shorter lines at airports security checks...

...and all these things...along with millions of others...will mean fewer jobs.

The news this morning tells us that the economy is still sinking. The latest figures show US GDP falling at a 0.5% rate. New York's governor said the slump will mean 45,000 layoffs on Wall Street - worse, he said, than the Great Depression. Gov. Paterson went on to say the state faces a deficit of more than $40 billion over the next 18 months.

In September, 159,000 layoffs were recorded. And now the LA Times predicts that even Hollywood will have to layoff workers.

Mortgage applications are still in decline. Housing prices are still falling. And the Wall Street Journal reports that not even drugs are selling.

Yes, dear reader, the people who caused the financial crisis - the feds - are now going to make the situation worse. Instead of letting the chips fall, they will prop them up as best they can...fighting the deflationary correction process every step of the way. The result will be a slump longer and harder than it should be...most likely becoming the First World Depression, FWD.

There were only two instances of major credit contractions in the 20th century. In each case, government intervened to stop the process of correction. And in each case - first in the United States after the crash of '29...then in Japan after the crash of '89 - the feds used every weapon in their arsenal to try to prevent deflation. And both times they only managed to deepen the pain...and stretch out the recovery over more than a decade.

Pity the poor investors in Japan! At the beginning of 2008, they had been waiting 18 years for a recovery. Instead, they got another 50% cut in the value of their stocks.

Bill Bonner
for The Daily Reckoning Australia

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