Federal Reserve - "print as much money as necessary"

NEW YORK, Dec 16 (Reuters) - U.S. stocks jumped 5 percent while the dollar tumbled and U.S. government debt yields slipped to fresh historic lows after the Federal Reserve surprised investors and cut interest rates to a range that includes zero percent.

The Fed also said it would employ "all available tools" to dispel the deepest recession in decades, a move equity markets cheered as investors said it showed Fed Chairman Ben Bernanke will do what it takes to get the U.S. economy rolling again.

Several weeks ago I blogged an item about the fear of deflation in the United States, and how the government is the most fearful because it is the largest debtor. Here's the analysis from the New York Times:

Though important as a historic milestone, the move to an interest rate of zero from 1 percent is largely symbolic. The funds rate, which affects what banks charge for lending their reserves to each other, had already fallen to nearly zero in recent days because banks have been so reluctant to do business.

Of much greater practical importance, the Fed bluntly announced that it would print as much money as necessary to revive the frozen credit markets and fight what is shaping up as the nation’s worst economic downturn since World War II.

That's a little scary. Actually it's a lot scary. Printing money as needed depreciates the value of money already in existence. It leads eventually, and invariably, to inflation. Robert Mugabe has demonstrated that principle quite effectively in recent years.

Another Reuters finance article suggests that the Fed is risking a new "bubble" - this time in dollars:

...the Fed’s decision to respond to the collapse of the technology and stock market bubble by lowering rates to 1 percent and holding them there for an extended period is now widely accepted as a mistake that contributed to the bond bubble and subsequent housing market boom in the middle of the decade.

If the low-rate strategy was a mistake, it was a conscious one. In testimony to the UK Parliament last year, former Bank of England Governor Eddie George admitted the bank had deliberately sought to stimulate the housing market and house prices to support consumption during the downturn.

Greenspan, Bernanke and Co seem to have adopted a similar approach in the United States. The real mistake, however, was not creating one bubble to offset the collapse of another, but believing they could control what they had wrought...

The problem is that if the unconventional monetary policy works, and the economy picks up, the Fed will come under pressure to “normalize” rates and reduce excess liquidity to prevent a rise in inflation. The resulting rate rises will inflict massive losses on anyone who bought [long] bonds at today's 2.25 percent rate.

If current Fed policy is perpetuated, the world will not want to hold U.S. dollars, and the dollar will fall against most major currencies. There is a deep and bitter irony in the fact that this country, which has prided itself for generations - and especially for the past eight years - on its military "defense," has now, as a result of its monetary and fiscal policies, rendered itself catastrophically susceptible to economic war. If China had any malevolent intentions against the United States, it could dump its treasury holdings onto the open market (at great cost to the PRC, but as a "wartime" maneuver it would be devastating). This country has never had its security threatened as much as it is threatened today.

Last January, right after I started this blog, I indicated that I was using ETFs to take short positions in the stock market. In the interest of full disclosure, I'll affirm today that I've maintained a short position through the year to offset my few remaining mutual funds. In view of recent developments suggesting a fall in the dollar, I'm now also establishing positions in gold using the GLD exchange-traded fund, both through purchases of shares and the selling of puts. I absolutely do NOT mean to recommend that others do the same; your financial decisions have to be based on your own situation, which may be markedly different re goals and risk tolerance.