Have We Seen This Fed Movie Before?

The bull market snapped back yesterday and prospects for modest economic recovery still look good. But I want to issue a warning or two about the latest policy statement from Bernanke & Company. I am not thrilled about it.

The Federal Reserve is keeping its fed funds target rate down near zero and is talking about adding another $1.5 trillion to its balance sheet through the purchase of mortgage bonds and Treasuries. Now, I don’t care whether those purchases come sooner or later. They represent massive new dollar creation and potential inflation. The Fed is targeting unemployment, not price stability or King Dollar.

Here’s my question: Is the Fed repeating the very same easy-money mistake it made between 2002 and 2005, when it totally bubbled-up and inflated housing, energy, and financial markets, all of which led to a 6 percent inflation rate down the road? Of course, all of that also led to a very deep recession. So color me worried.

Distinguished monetary historian and Fed expert Alan Meltzer from Carnegie Mellon says the Fed needs to wind down the printing of excess cash and balance-sheet expansion in order to stop future inflation. He’s absolutely right.

And even if government health-care control doesn’t pass, it’s bad enough that Uncle Sam is borrowing too much and spending too much. This will slow future prosperity and bias the system toward inflation.

In the short run, excess liquidity from the Fed may be good for stocks. In the longer term, it is not good for stocks, the economy, or your pocketbook.