Hussman Weekly Market Comment: Will the Real Phillips Curve Please Stand Up?

I've long argued that the Fed has an essential function in providing liquidity during periods of banking crisis, but I have been dismayed by the extent to which the Fed has breached the restrictions of the Federal Reserve Act in recent years, as well as by the increasingly distortive policies it has pursued.

Market veteran Ned Davis puts it nicely "I think the Fed has punished savers and has put us between a rock and a hard place with QE2. It has kept the banking system liquid and helped goose stocks. But in that it has also provided juice for a commodity explosion that has hurt the world's poor, it has offset much, if not all, the good it did. In that real money (ex inflation) matters, the situation is not nearly as favorable as most Fed watchers believe."

Similarly, Vitaliy Katsenelson related a recent speech by the Fed's Thomas Hoenig at the Colorado CFA Society - "He said these policies encourage speculation and don't allow for price discovery, and consequently they lead to imbalances, unintended consequences, and misallocation of resources. He said it is important to judge QE2's success over the right time frame, one long enough to encompass not just its stimulative benefits but also its consequences." Hoenig argued that the Fed's intervention will have unintended consequences, and offered as an example the Fed's actions of 2003, the resulting asset bubble, and the subsequent financial crisis that resulted. Vitaliy observed "I too believe that the Fed's actions in 2003 played a very large role in the subsequent real estate bubble, financial crisis, and today's high unemployment, but this was the first time I've heard such an admission come directly from a Fed governor."

With respect to the Bernanke's actions, Vitaliy quoted the 19th century economist Frederic Bastiat:

"There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen... the bad economist pursues a small present good that will be followed by a great evil to come, while the good economist pursues a great good to come, at the risk of a small present evil."