Monetary Policy

As was widely expected, the Fed has left policy unchanged. ZIRP
stays. The economy has turned up, and the breadth of businesses
reporting higher activity levels has risen sharply, especially in
manufacturing. The monthly data is volatile, but the economy has
cleared the first hurdle toward a decision to boost rates. However,
plant utilization is a full 10 percentage points below levels where
the Fed generally raises rates. The Fed is thus holding to the
historic view that much higher levels of resource utilization are
required to warrant a firming of monetary policy. As well, my
short term business credit supply / demand balance is very soft
as loans continue to roll off the books in reponse to much lower
working capital needs. This can continue, as businesses often
generate sufficient internal cash flow to handle early stage
recovery needs. My yr / yr measure of broad credit driven
liquidity is still down in % terms. Thus the Fed and the Treasury
remain the primary providers of increments to liquidity in the
financial system.

With the CPI at a + 2.6% annual rate through Sept., real short
rates are negative and continue to be hosed. Thus the US dollar
is losing purchasing power at home. For now, the Fed, in moving
to liquify the system and keep interest rates low, is running well
behind the inflation curve.

Pundits have made much of the postive slope of the yield curve
and how it, through a positive cost of carry, as well as the ZIRP
policy, are funding a recovery of asset values. This is a normal
cyclical development, and the liquidity available for asset
speculation will dry up as the real economy recovers and claims
additional liquidity. In fact, you have to be careful with this since
financial liquidity, when measured broadly, has been contracting.
This means that as the economy improves, the velocity of money
is rising from low levels and that excess liquidity is contracting from
high levels. Talk of "asset bubble" conditions is decidedly early,
to say the least.