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Fed's weapon of mass desperation
and The Ka-poom Theory

House prices may fall 40-50 percent
Wolfgang Münchau, Financial Times, November 23 2008

Until recently, most of the housing experts were content to predict a 25-30 per cent fall in US prices – peak to trough. Such a fall would bring prices back in line with the long-term trend. But this was before an expected mild downturn turned into a big recession, and credit froze up.

Under such conditions, one would expect house prices to overshoot, say at least 10 or 20 percentage points beyond the trend line. So we may be talking about a peak-to-trough fall of 40-50 per cent on average in nominal terms – and more in real terms.
There is no reason to see why the downturn should be any different in the UK, Ireland and Spain.

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Fed's weapon of mass desperation
The mother of all bond market crashes
Wolfgang Münchau, Financial Times, November 23 2008

There are risks both ways – asymmetric perhaps, but surely significant, both in terms of their impact and their probability.

Under a strategy of quantitative easing, the Fed does not care about the rate. The goal is to increase the money supply, by swamping the Fed funds market with liquidity.
The calculation is that this would give banks an incentive to buy higher yielding securities, which would reduce long-term interest rates, over which the central bank has no direct influence.

For a central bank, this is comparable to the deployment of the nuclear option – your last or last-but-one policy option. Ben Bernanke, the chairman of the Fed, once co-wrote a paper on the subject of what a central bank can do when interest rates hit the “zero bound”* – a zero rate. The answer is that there are a few options, quantitative easing among them.
It is interesting, though, that he has already deployed his weapon of mass desperation while still some distance away from the zero bound.

The recession in the western economies might end in the middle of next year. With interest rates close to zero, borrowing would pick up fast. Oil and commodity prices would rise as fast as they came down. I would expect the central banks to be too slow in raising their interest rates for fear of killing off the incipient recovery.

The result would be a sudden rise in inflation, perhaps the mother of all bond market crashes and, quite possibly, a dollar crisis.

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The Ka-Poom Theory
The deflation-inflation two-step
by Eric Janszen Last edited by jimmygu3; 11-13-2008

The Ka-Poom Theory explains how, following the collapse of the credit bubble, the US economy will experience a short (six month to one year) period of deflation that we call disinflation, such as we are experiencing today, followed by a major inflation induced by monetary and fiscal policy and the actions of US trade partners in response to that inflation.

It appears that the deflationista camp is incapable of comprehending a model, and the events that it forecasts, that lays out a two step process. For some reason they cannot grasp the fact governments will respond to disinflation with inflation, that the impact of those interventions is not instantaneous, and that markets historically are not very good at foreseeing the change in inflationary conditions in either direction.

The deflationistas apparently think what comes after post-bubble deflation is more deflation, as occurred in the early 1930s in the US but nowhere else ever since. It has not occurred to the deflationists why no similar period of deflation has ever occurred since the 1930s, or when they do confront the question they explain that the debt is really, really, really big debt this time, bigger than the Fed. Or that differences between the kind of money that the Fed prints versus the kind of money that the endogenous credit markets create when money is loaned into being by businesses and consumers means the Fed cannot impact the latter.

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