Tuesday, September 18, 2007

Break out the Bubbly: Fed Cuts Fed Funds Rate .5% to 4.75%

About 20 minutes ago Bloomberg television reported that the Fed cut its benchmark rate by .5% to 4.75%. This cut was on the high end of its expected actions. The Dow ended the day 335 points higher (I think it had been down about 40 points before the announcement). As I blogged yesterday, cutting reinforces Ben Bernanke's and the Fed's new role of casino manager who, by selling ever more poker chips, takes ever greater risks of a run on the casino, a run which would put many Americans into the poor house. Of course, there are two effects of increasing the number of poker chips, or should I call them dollars. The first is a run up in asset valuations (because low interest rates increase the present value of earnings and because firms need to pay less when they borrow). In the past, this lead to an increase in employment, but in recent years has stimulated cost cutting as executives have been keen to boost stock valuations and so move their plants overseas. The second is inflation. Since the poor consume their income, inflation hurts them the most. Since the wealthy hold stocks and real estate, asset run ups help them. The result is increasing income inequality.

The MSM avoids discussion of this tautological, rather obvious relationship among inflation, asset run ups and income inequality, mainly because Wall Street and other wealthy asset holders don't like to admit that they are wealthy because of government welfare via the Fed. For example, the Economist of September 15-21, 2007 (p. 15) carries a leader that emphasizes the short run relationship between job creation and economic growth on the one hand and interest rates on the other. To its credit, the Economist argues that

"lower interest rates will not achieve all that much...it would be irresponsible of them to slash the Fed funds rate...Nor will a moderately lower Fed funds rate do much to stop the economy from slowing...History suggest (Wall Street) may not (react modestly to the size of the cut)"

But the Economist, friend of the City of London and Wall Street, avoids discussion of the implications of rate cuts for income inequality.

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