How a lender bailout hurts the economy

The Federal Reserve's efforts to ease the credit crunch risk stoking inflation - and letting reckless, well-paid execs off the hook.

NEW YORK (Fortune) -- The government is showing considerable ingenuity in devising new tactics to fight the credit crunch. But some observers fear that the innovations risk making matters worse - by fueling inflation and insulating executives who made reckless bets from the full wrath of the market.

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David Rosenberg, chief North American economist at Merrill Lynch (MER, Fortune 500), wrote Wednesday that this week's Fed action will do little to counter the impression that Bernanke & Co. is struggling with problems that the Fed ultimately has little control over. "This latest experiment, as with the others undertaken thus far, does not address underlying credit problems, does not materially improve the solvency of the institutions exposed to assets under stress, does nothing to put a floor under home prices," Rosenberg wrote in a note to clients. "We see no reason based on this for anyone to change their economic or earnings outlook despite the stock market's initial reaction to this latest initiative."

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"We're in the helicopter phase now," says Howard Simons, a strategist at Bianco Research in Chicago. He references the nickname Helicopter Ben, which Bernanke got tagged with after a 2002 speech on how central banks can steer away from deflation by dropping money into the economy.

 

Clearly, not everybody is cheering the actions of Ben Bernanke quite as much as the breathless commentators on CNBC would have you believe.

 

If you've been to one of my seminars you know that Ben Bernanke is doing precisely what he said he would do when faced with this exact problem - namely, throw ever increasing quantities of easy/free money at the problem until either:

  1. The problem was solved
  2. The entire system broke

Of course, this made our investing lives very easy as he told us, unequivocally, that storing our wealth in US dollars was a very bad idea and was even nice enough to say so in a major position paper that was publicly distributed.

 

Here's the relevant quote [Link to full article]:

Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

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