22 Sep 2008

Did the Market Call Paulson’s Bluff?

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As of 10:40 AM Monday morning, the S&P 500 is down almost 1.5%. Notice how the short-term euphoria from the government’s progressively bigger interventions is more and more fleeting, as the months roll by?

Investors are apparently starting to realize that Paulson and Bernanke are bluffing. They can’t undo the housing bust. All they can do is rearrange a few trillion dollars, but that’s a negative sum game, once the incentive effects are taken into account.

In macroeconomics it took a while but finally they learned that if the central bank keeps price inflation down, then the short-term growth from an unanticipated injection of new money is pretty high. But if the central bank keeps injecting more and more funny money into the system, then after a while the public adapts and these injections become necessary just to maintain the status quo.

It seems we are nearing that point with Paulson’s power grabs. He basically took over the nation’s credit markets last week, and it bought him two business days’ of relief.

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