Monday, January 12, 2009

Massive Government Intervention Causes Capital To Become Skittish

It's beyond me why anyone thinks the government massively and arbitrarily jacking things around in unpredictable ways with unknown side effects is going to help anything.

Here's a good blog post that examines the question.


Printing Uncertainty

Getting slapped in the face doesn't generally build confidence, and can lead to uncertainty of pick-up line quality. Quantitative and qualitative easing do not necessarily lead to a risk-taking appetite in the private sector, nor do they necessarily lead to serious inflation, which depends on many factors.

Intervention clouds economic signals, the ones the private hand uses to direct us in the right endeavors. It's very hard for anyone to get a handle on relative pricing in the near future and present, or judge a worthy risk, when second-round effects from deflation, credit creation, and strenuous government intervention must be factored in. This can lead us to do the wrong thing, or more likely in our modern day and age, do nothing at all.

Banks might be worried about Buiter's sudden resurgence in inflation creaming them on a long-term loan they make for development. Borrowers might take a sober assessment of pricing power and expenses in their industry, look at end unit sales projections, and fear deflation will persist. While strong inflation would be good for the borrower, and strong deflation might sorta possibly be good for the lender, both face extreme uncertainty in their projections, and paralysis results.

The slaps themselves might actually be contributing to the paralysis in the financial markets, too. The Fed and the government can crowd the private sector out of these marketplaces by setting artificial clearing prices. Imagine there's a lender who sees a 10% risk of default by a borrower. They then might be willing to lend out money at 12%. However, if the government intervenes to drive the rate down to 8% forcibly, that loan will not be made by the private sector at all.

If I knew I were trading in a market where the Fed were present, I would have precisely one strategy: front-run the Fed. This front-running makes intervention more expensive for the Fed, and is profitable for the front-runners, but it doesn't encourage the private sector to take the reins again. As the most visible example, the Fed now owns roughly 20.5% of the commercial paper outstanding. The latest release shows this has little to do with year-end effects, and the percentage has been gradually increasing since the program was initiated. The government will gradually issue or own more and more loans, and the private sector could continue to recede.

Finally, just to throw in one more feedback loop, let's imagine we hit moderate to high inflation. As readers observed on my last post, the value of a phenomenal amount of longer-dated fixed coupon assets outstanding would get crushed, destroying a lot of players and money. That -- or even its credible possibility -- isn't good for real investment or certainty either, and would require even more rescues by the government.

The paralysis and uncertainty engendered by our intervention are, in my opinion, worse even than the alternatives. People must have faith in currency as a mechanism for accurate pricing information and storing wealth. If we destroy that in our quest to inflate our way to victory, what have we won?

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