BarroMetrics Views: Questions on the FRED graph

Thomas Young asked a series of questions, my response below the question.

Hi Tom…..

‘Ray,

 I read your October blog post on the Fred Graph where you suggest that a stock market downward turn may come in the Jan11-Apr11 window.

As I understand your point, when banks go back to lending at more “normal” levels, the Fed will have to suck liquidity (M1) out of the system and reverse the exponential liquidity injections over the last couple of years.  Raising rates, increasing reserve requirements, etc.  This will push the equity markets down to test new lows (S&P 666).

RB: Yes so far as para 2 is concerned.

But the downturn you mention in Jan 11 to April 11 will probably not be the downturn marked by the FRED  graph. That will likely come in Sept-Oct 2011. As a rule the CPI turns react to the FRED about 6-months after a decisive FRED turn.

 Your argument assumes that the Fed will act to control inflation as their past behavior and charter would suggest.  Do you think that this time they will try and manage “high” inflation as a means of monetizing national debt?  If not, why not?

RB: They probably will but hopefully not be so tardy in raising rates that hyperinflation results. And that answers to your second question here. The reason why governments don’t merrily expand the money supply is because expansion has consequences, the most serious of which is hyperinflation.

 Also, another scenario is that the Fed will not be able to reduce liquidity levels as fast as they increase them.  If lending starts abruptly or banks dumps dollars for foreign reserves or gold - the Fed will not be able to catch the inflation genie.

What is you current thinking?’

It is almost a given that the FED will not reduce liquidity as fast as it has increased it and as a result may not catch the inflation genie. Hopefully that won’t be the case. We’ll just have to wait and see.

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