Are We Setting Up a Black Swan Event?

Interest rates are at zero and cannot go any lower. The Federal Reserve has stopped buying US Treasuries and is phasing out purchases of mortgage backed securities. Bernanke has essentially announced that he has done his part and will now wait and see what the results are.

The stimulus money has been allocated out, is being spent and now will taper off for the next couple of years. Obama is calling for governmental agencies to cut their budgets 5 percent and is considering using repaid TARP funds to reduce the deficit.

In my opinion, we are setting ourselves up for a Black Swan Event. My reasoning is as follows.

All of the actions taken to date (ZIRP, QE, fiscal) were insufficient to establish sustained economic growth against the ongoing headwinds of credit contraction.

The measures to date will bring on a temporary spurt of economic activity that will disguise the fact that the broad economy has continued to deteriorate. Thus, the downward path will not become apparent to policy makers until after the temporary growth spurt has played out.

By the time the continued downward trend of the economy is confirmed and acted upon it will be "too late". The economy by then will have "committed itself" to a strong secondary recession.

It will be much harder to engage in additional stimulus measures at that time because there will be a greater global loss of confidence in the US economy and in the ability of our policy makers to take the appropriate steps to extract the economy from the decline.

Further, the declining economy means federal deficit projections will be greater than what is projected today even before a new round of stimulus is contemplated. Even QE may be difficult to undertake if the dollar has weakened significantly in the interim.

In other words, we might not have stimulated the economy enough in the first go around to create sustained growth. If so,embarking on a "wait and see" pause, while perhaps a safe bet politically for Bernanke and the Federal Reserve, might be the worst course of action to take for the long term health of the economy.

I believe we saw this scenario play out last year. You recall the $800 stimulus checks in May - July provided additional discretionary income which encouraged consumption & offset higher gas prices during the summer. However, while this economic activity was being generated, beneath the surface so to speak the housing and financial markets were disintegrating.

Today may not be much different. While inventory restocking and temporary housing and auto measures have generated a bit of economic activity, elsewhere the economy continues on a downward trajectory. Housing starts, CRE, mfg, existing & new home sales, layoffs, small business closures, state & local govt budget deficits, bankruptcies, foreclosures, credit contraction etc. are all eating away at the foundations of the economy like termites.

It would be much better to risk inflation that can be mopped up later after economic growth has been sustained. To think we will go "Weimar" with our structural unemployment and surplus capacity seems unrealistic.