A new headache for the Fed

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US Federal Reserve (Fed) Chairman Ben S. Bernanke. Photo – Brooks Kraft/Corbis

The Fed is facing a new problem seeing the pursuit of its expansionary monetary policy. At one hand, it has liquidated the markets with bond buying which is the only ploy it can use in order to stimulate the market. With interests being at an all-time low, there was a need to stimulate the market to target unemployment and the best ploy was to use opening market bond buying which was being carried out. Now, however, there are new concerns that the excess of liquidity was being used to purchase assets leading to a new asset bubble building up.

This is a bigger concern right now considering the fact that asset bubbles are usually present in booming economies and show overheating of one asset class in particular being heavily overweighed. In this case, the dollar, gold and commodity markets have seen some strengthen till last week where bad economic data, couple with a limit on asset buying saw a crash in the gold prices. There is a lack of safe haven for the investors and no one is sure what to buy at this point of time.

With currencies already plummeting, euro hitting a new low, yen being questioned over manipulation, the dollar is seen to be strengthening. Oil is also going through tumultuous times with manufacturing data causing volatility in recent weeks. In this situation, the Fed has the unenviable job of balancing the good with the bad. The good of stimulating growth in the economy that is substantial and real and to avoid short term goals of asset bubbles being created.

The recent speech by Ben Bernanke, Fed Chairman, has said to have rejected these concerns even though there is a rise in prices of farmlands and mortgages made by certain financial institutions based on these rise in prices. The fall in asset purchases by Fed itself was caused by the feeling that too much purchase could lead to growth that was not based on fundamentals. There is a need for growth to take place which is reflected in lesser unemployment, rise in GDP and a rise in borrowing by the retail sector.

That has not been seen till now and even though job data had been improving, it seems to have plateaued. Critics show that the prices of bonds, agricultural land, and leveraged loans are at a record high and if the policies keep going as they are, the bubbles would only get bigger and more troublesome. The problem for the Fed right now is to channel a path that is not based on history but to charter a new one which is able to meet the goals of low inflation and unemployment while not risking the whole system onto more and more bond buying.

This would mean some head scratching at the Fed and the situation of gold, currency and oil markets only makes it tougher for the, to do anything at this point of time. The next news out of the Fed concerning their moves would be interesting to know and it would have to be seen whether markets give a positive outlook to it or ignore the announcement which can further deepen the slump that the American economy is in.

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