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Hey Denny...

"If the Fed manages to undo this then all that has happened is that taxpayers replenished bank reserves -- a hidden tax."

That's an awfully big "if", isn't it? They couldn't see that the subprime meltdown would spread to the general economy a full year after it began. Now they've put us past the extreme boundaries of historical monetary policy... in an experiment without precedent... and we have to cross our fingers and hope that they will be able to perfectly reel us in, extricate us without consequence and time it correctly to boot? Color me skeptical.

Velocity is low because interest rates are low and depressed cost of capital allows banks/institutions/etc. to sit on mountains of under-performing and low-yield assets indefinitely. When interest rates normalize, velocity goes up as they can't cover their cost of capital anymore and have to invest in more productive assets. Garbage businesses will die and good ones will take up the slack and thrive. The problem is that the Fed won't risk tanking recovery by shrinking its balance sheet prematurely, but we can't recover while institutions have no incentive to put capital to work productively. It's beyond me to predict how it plays out, but I bet big money that it's also beyond the Fed and every other policy maker at this point to correctly predict the array of unintended consequences. Probably the worst case scenario is that interst rates stay historically low for a long period of time, though that would surely keep inflation at bay. Probably won't be good for anybody holding any assets other than treasuries though.

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