Edited Partial Article courtesy of MoneyNews.com

Economist: Fed Cuts Responsible for Mess

One of the leading economists in the U.S. , Brian Wesbury of First Trust Advisors, LP, now says the government's monetary policy is partly to blame for the ongoing malaise in the financial sector.

Non-stop interest rate cuts over the past few months may have created a perverse incentive for businesses to postpone activity, Wesbury noted in a daily briefing.

"Why do something today if rates will be lower next week or month?” asks Wesbury.

"Aggressive rate cutting has been ineffective. Without liquidity and capital, financial institutions and trading vehicles are in trouble.”

This includes, Wesbury says, the recent headaches at Carlyle Capital, which liquidated its entire portfolio of mortgage-backed securities, valued at $22.7 billion.

"Cutting interest rates at a time of heightened risk also undermines the willingness of some investors to stay invested,” says Wesbury. "Think repos, or auction rate preferred securities.”

The Fed's last move is likely to exacerbate an already bad situation. The federal funds rate — the interest rate that banks charge each other — sits at 2.25 percent, the lowest point since 2004.

Fed Chairman Ben Bernanke and his team have cut the funds rate six times since last September, with this last cut marking the second back-to-back slice of three-quarters of a percentage point.

President Bush responded by saying that the government will take further action to help the financial sector of the U.S. economy.

That has not, however, boosted confidence. Rather, the government is "signaling that economic conditions are desperately bad and that the [government is] panicking and unable to fix the problem,” says Peter S. Cohan, an economist in Marlborough , Mass.

The Fed is actually not doing the job it is supposed to do, says William Shughart, a senior fellow at the Independence Institute, a think tank in Oakland , Calif.

The Fed, he says, has lost sight of its job of "promoting price stability through sound management of the nation's money supply.”

According to Wesbury, whose firm published a research report, entitled, "Another Ride on the Fed's Asset-Centric Rollercoaster,” this policy miscue has deep roots, ones which extend to years ago, before the current economic conditions.

"The root cause of the Fed's mistake is that for the past 10 years, it has been asset-centric, rather than inflation-centric,” says Wesbury.

"This asset-centrism started in the late 1990s when, despite rampant signs of deflation, like falling gold prices, the Fed raised rates to prick the stock market bubble.”

The market, at that time, did not respond quickly. Tight money made the dollar strong, and U.S. investments became more attractive for overseas investors.

"Eventually, however, tight money cracked the market severely and caused deflation,” says Wesbury.

This continued through the collapse of the NASDAQ in 2002 and 2003, as the Fed pushed rates below inflation.

"The Fed policy of accommodation and gradualism caused a housing bubble, which in turn created today's mess,” says Wesbury. "Despite all this, the Fed has not learned. It is focused on asset prices and not inflation.” Fortunately, appropropriately protected hard assets that survive the current instability will act as a hedge for inflation.

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