Yesterday, in a bid to reassure nervous investors, Federal Reserve chief, Ben Bernanke, announced that the central bank was going to try to put the toothpaste back into the tube.

The markets weren't impressed by Bernanke's hint that the Fed is ready to cut half a precent off the Fed Rate at the end of this month. There was a time, a couple of years ago, when the Fed could have made a difference, not by cutting rates, but raising them to cool the overheated housing market. But the Fed (and Federal banking regulators) succumbed to pressure from the lenders, builders, Security dealers and Realtors who were feasting off the bubble easy credit had created.

Back then no one was interested in lectures from the Fed on sustainability or risk. Then was the time to reel them in, kicking and screaming and accusing the Fed of driving the economy into the tank with higher interest rates. If they had the market would not be in the tank, and heading into recession today.

Here's why Fed rates cuts now will not -- cannot -- work.

First here are the only choices the Fed has to choose from now:

1) Avoid a recession by sparking inflation

2) Avoid inflation by causing a recession

3) Have both at the same time -- stagflation.

Option 1) The Fed could try to avoid a recession by lowering interest rates and increasing the money supply. The idea would be to encourage more borrowing and another round of consumer spending. That would do it, at least in the short run. But that would just put things back where they were before the housing bubble burst. Consumers are already burdened by more debt than they can manage. And the combination of more borrowing and an economy awash in printed money would surely ignite raging inflation.

Once that happens everyone starts chasing their own tail. Workers demand a raise to keep up with the cost of living. Those higher wages spark more inflation. Consumers can feel their cash losing value in their wallets and purses and therefore exchange (spend) them for "stuff" because "stuff" at least is increasing in value. The demand for "stuff" thusly drives the price of "stuff" even higher .. and on and on it goes. (Gold hit $900 an oz. today, not because gold is intrinsically worth that, but because gold is the "stuff" of choice for investors when paper money starts losing value.)

Option 2) The inevitable surge in inflation would eventually force the Fed to increase interest rates. But raising rates would drive already debt-burdened consumers even deeper into trouble. Credit card companies tie their rates to benchmark rates, like the prime rate. Then they add their usurious mark up to that. So, when the Fed raises it's rate it trickles through the entire system. Credit card rates jump from an already unconscionable 20% to $25%. Be one day late on paying your monthly minimum payment and that rate can soar above 30%. (Eat your heart of out John Gotti.)

And then there's the already moribund housing market. Higher interest rates now would be like trying to cure a guy with cirrhosis of the liver by putting him on a straight moonshine diet.

Option 3) Stagflation is often described as getting hit with the worst aspects of a recession and runaway inflation at the same time. I lived through the last bout of stagflation, during the Carter administration. His predecessor, Gerald Ford, had left things in quite a hash, and it only got worse during the Carter administration. All Ford did was have a few lapel buttons printed up that read: W.I.N. -- which stood for "Whip Inflation Now!" Somewhere in the bowels of the Capitol or in a dark corner of the White House basement are boxes full of rusting and dusty WIN buttons.

At this point in time, stagflation this looks like the most likely outcome of the troubles that face the economy. If we get out of this mess with just a three or four years of stagflation, we should consider ourselves lucky because, with Options 1 & 2 clearly not a solution, stagflation is the only option standing in way of an old-time depression.

The markets know that too. Which is why Bernanke's rate cut promise yesterday was met this morning with a resounding vote of no confidence from Wall Street. That should be no surprise since Wall Street firms, having had a big hand in creating this mess in the first place, may be the only folks on earth who know where all the investment zombies they created are hidden.

As for Bernanke's promise that the Fed is ready to do whatever it can to head off recession, it's not that it's too little, it's that it's too late. Fed inaction when they really could have had a meaningful impact, had now made the Federal Reserve all but irrelevant. Bernanke is now just another captive rider on the roll coaster with the rest of us.

I wonder if he'll scream?

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newsforreal.com



About author Stephen Pizzo is the author of numerous books, including "Inside Job: The Looting of America's Savings and Loans," which was nominated for a Pulitzer. His web site is Stephen Pizzo is the author of numerous books, including "Inside Job: The Looting of America's Savings and Loans," which was nominated for a Pulitzer. His web site is News For Real