[RT] Fed's response in a deflationary environment

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Part of the problem in trying to stick-handle one's way through the
markets these days is not knowing how or if the Fed will respond to
crises and how it will respond to a disinflationary (or deflationary)
recession.  Here is a copy of Fed Chairman Bernanke's November 2002
speech in which he described some of the actions the Fed could take
after the federal funds rate reaches zero and interest rate policy is
no longer effective.

We are now seeing some of the actions he outlined, and others are
clearly on the horizon.  One of the more disconcerting measures is the
Fed capping Treasury bond yields by aggressively buying maturities up
to six years.  The theory is that low yields restart spending (which I
think is flawed logic) and not only will this peg shorter-term yields,
but it will also influence long-term Treasury yields (since long term
rates comprise current short term rates and expected future short term
rates).  Bernanke believes -- and I think his logic is flawed here,
too -- that low Treasury bond yields will cause corporate debt yields
and mortgage rates to fall.  I think we'll just see even greater
spreads between Treasury yields and corporate debt.

Also, as inflation approaches zero, investors will accept lower and
lower yields (as we're seeing now).  So, short of capping Treasury
bonds at negative yields, I don't see that the Fed has a lot of
maneuvering room here.

He outlines other measures like buying foreign government debt to
affect foreign exchange rates -- a more elegant way of devaluing the
dollar than Roosevelt's arbitrary experiments with setting gold prices
in 1933.

The Fed's actions will distort the markets and will hurt a lot of
people, but it will also create opportunities for people who are
prepared.  Forewarned is forearmed.
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Attachment: Deflation-Making Sure it Doesn't Happen Here.pdf
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