Expert Commentary

High Noon For The Fed's Credibility

This article originally appeared in the December 14, 2007 issue of The Elliott Wave Theorist. Fifteen months later, the stock market had fallen by more than half and commodities had crashed in the first deflationary wave.

On one end of the dusty street stand five outlaws: the Federal Reserve, the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank. On the other end of the street stands the monster that they created and nurtured in their global lab. The outlaws have opened with a barrage of bullets. But the only bullets they have are made of the monster's very substance: debt. Every bullet that hits him only makes him stronger. And now the monster is beginning to draw his gun, and it's a bazooka. He is taking aim. The monster is about to overcome his makers.

Last Chance Saloon

The world's "big five" central banks -- the Federal Reserve, the Bank of Canada, the Bank of England, the European Central Bank and the Swiss National Bank -- have just made the announcement of their lives. Apparently working all night on Tuesday-Wednesday, the Fed arranged all these players' cooperation in order to come up with a plan to bolster confidence among the world's creditors and borrowers. The Wall Street Journal (12/13) calls it "the biggest coordinated show of international financial force since Sept. 11, 2001." As a result, before Wednesday's U.S. stock-market opening, this consortium of money monopolists announced to the world that it would provide billions of dollars worth of "liquidity" in the form of low-cost, one-month loans to qualified banks with high-quality collateral, essentially presenting them free passes to make money in the LIBOR market and elsewhere. In this one blazing statement broadcast worldwide, it seems that the dream/nightmare of believers in perpetual inflation has come true: With unlimited fiat credit at their disposal, the world's central banks are proudly coordinating a drive to create more inflation.

But the seems is different from the is. If these central banks had pledged to exchange their IOUs indiscriminately and permanently for any and all other debts, they would indeed have created permanent inflation. But this new plan is just another repo deal, in which the borrowing banks still have to pay back the money, with interest, in 28-30 days. What's more, weak debt is not acceptable collateral; these central banks are willing to hold only the good stuff, and then only for a month. As EWT has argued many times, there has been no indication whatsoever that the Fed is about to begin swapping its IOUs for subprime mortgages or any other junk paper. They will accept only good debt, and only for 30 days. Very little has changed.

Nevertheless, this is probably the single most important central-bank pronouncement yet. But it is not significant for the reasons people think. By far most people take such pronouncements at face value, presume that what the authorities promise will happen and reason from there. But the tremendous significance of this seismic engagement of the monetary jawbone is that if this announcement fails to restore confidence, central bankers' credibility will evaporate.

At least that's the way historians will play it. But of course, the true causality, as elucidated by socionomics, is that an evaporation of confidence will make the central bankers' plans fail. The outcome is predicated on psychology. If wave c of the bear market has begun, nothing the Fed does will engender confidence. On the contrary, everything it does will be interpreted, in the trend toward negative social mood, as something bad. The Fed's failures will not create fear; fear will create the Fed's failures.