The Great Experiment

Since early last fall, it's been my strong opinion that the real (and only) solution to the financial situation was to have the Fed pump huge amounts of liquidity into the system. Instead, we got TARP's and bailouts and stimulus packages and all kinds of stuff. The stock market continuously tanked in response to all those packages and the financial system continued to be mired in fear, uncertainty and doubt.

Finally, in early March, the Fed did just what I hoped they would:

"...the Bernanke Fed launched another shock-and-awe stimulus plan that will expand the Fed’s balance sheet another $1.2 trillion through the purchase of $300 billion in long-dated Treasuries, $750 billion in mortgage-backed securities (Fan/Fred), and another $100 billion in U.S. agency debt."

Sure enough, the stock market had its biggest rally in many months in response. Banks are looking healthier, the financial system is starting to look a bit more stable, and some economic indicators are starting to point to a recovery.

I'm really happy the Fed finally did this. Beyond the fact that I thought it would help, it's also a very interesting experiment. The second half of the experiment will take place in the future. The Fed created a huge amount of liquidity. Eventually, as the credit markets thaw completely and money velocity returns to normal levels, the Fed will need to mop up all that excess liquidity or the economy will drown in all that extra money. I'm hoping they have the resolve to do the right thing. I think they can, but not everybody agrees with me. If I'm wrong, we'll see quite an uptick in inflation, probably starting in the next several months.

But my curiosity will be sated either way.