"In matters of style swim with the current, in matters of principle-stand like a rock"
Thomas Jefferson

Someone famous once said "Invest in inflation. It's the only thing that is going up" and you know what- I could not agree more. In this world of fiat money one thing is guaranteed - your money will be worth less tomorrow than today. As you might have guessed from my previous posts I am not a great believer in politicians' abilities to guide/understand the economy in general, and definitely get extremely irritated when some of the most vocal and most popular of them try to give advice to the Fed. This advice usually says something like this:" I can't believe you have not reduced rates yet... What the hell is taking you so long-my constituents are suffering and you are doing nothing about it... etc." I think there should be a prize of some sort that is awarded annually to a politician that actually asks to increase rates for once- the only problem is - this prize could go unclaimed for years...

I've posted my opinion on the subject of Fed's rate cuts many times in the past and instead of reinventing the wheel will just repost some of my previous thoughts as I think they have not yet lost their relevance...

I think the next few weeks will determine the direction of where the world largest economy will be heading for the next few years. If you read most of the mainstream press it sounds like this direction is clear- another rate cut, followed by shallow recession and bright future from thereon forward. Not so fast...It's definitely easy to be a politician and make it look like all of the world's economic problems could be magically wiped off the face of the Earth by a swift downward hand movement of a wizard called Ben Bernanke...

The truth, as usual, is that popular opinions always swing too far. Rate cuts are rarely followed by a period of short term market out performance and thus problems will not just simply go away. What's more in most recent rate cut cycles the decisions when to start cutting were relatively simple (9.11, debt crisis etc) and most of the time were on target. The more difficult decision is when to stop cutting rates and that's where we might've had less success with the outcome- at least some of the current problems are due to what many believe was one of the few mistakes Alan Greenspan has made- cutting rates too low.

This time Ben's decision is neither easy nor warranted by a consistent pool of homogenous data. There wasn't a major stock market crash (5% YTD decline is merely a correction), corporate earnings outside of financial sector are still climbing (albeit very slowly). What's more oil has just hit a new all time high just a few weeks ago, copper is pushing multi months highs, wheat is at all time high as well. Inflation overall is still stubbornly high and is above or in the higher range of the desired 1-2% corridor; dollar is pushing all time lows against the euro, agriculture bubble is only getting fluffier every day, rents are still climbing, consumers are still spending...

The question now is whether all of the above is just a lagging indicator of the irrational behavior from the excesses of the last five years. Liquidity struggles of the last six months have not yet been resolved completely even though normality is slowly coming back into the financial system. So the real issue is whether Ben is going to bow under pressure and will swim with the current of the "cutting mood" or will he acknowledge that maintaining price stability is the most important role that Fed plays and that buckling under popular pressure is the easiest way for introducing unnecessary volatility and excesses into the otherwise well functioning economic machine. Inflation beast has not been defeated yet and until that occurs everything else (growth or unemployment) to me is less relevant.

Playing with size of cap of Freddie's and Fannie's mortgage portfolios, accepting new forms of collateral for the Repo agreements as well as introducing new regulation into the lending world are purely matters of style and thus in this case my advice for Ben would be to swim with the current. Let politicians have their time in the light- it's not worth fighting over.

However maintaining price stability IS the matter of PRINCIPLE and standing like a rock is the only appropriate stance that Ben Bernanke should take. I've been wrong before, but I hope that Ben and Co will now realize that dropping Fed Funds rate any further is simply going to add more gasoline to the "commodities bubble" fire. We have to be realistic- inflation expectations have to be brought under control until it's too late. And the best way to do it would to finally buck the market desires and DO NOT cut rates, otherwise, Paul Volcker might just have to eventually take on Ben's job and expectations for a V shaped recession could very well become a W or may be even WW one...

My neutral stance towards the equities is starting to turn somewhat bearish due to the fact that too many mainstream "talking heads" started to sound bullish again and decline in the VIX index shows that people may be starting to feel too optimistic again...

P.S. I've had some issues with the portfolio tracking system here at MSN where some of the holdings showed up one day and disappeared the next one, which made it difficult to assess what my holdings actually looked like. It will probably take several weeks just to clean my portfolio up and bring it back into the correct long/short/cash balance. For now, I have exited most of my O&G/alt-E plays (SLB, DO, NE, JASO, ESV) and incurred some losses on the short side...

Feel free to e-mail me at skepticalcapitalist@gmail.com