Fed should maintain QE and create moderate inflation

Dow dropped another 634 points today. A lot of fear in the market. This isn't because of the S&P downgrade. Investors are panicking over slowing growth or a potential contraction. Are we heading right back to recession? What can one expect from the Federal Reserve which is having a FOMC meeting tomorrow?

Ken Rogoff expressed a clear view in this interview. He thinks that the Fed should have never stopped QE2, in fact he thinks that the Fed should make it open ended and make it clear the objective is to create inflation.

Quoting Bloomberg:

Rogoff recommended the Fed say in “very clear statements” that it’s trying to create “moderate inflation.” “In the classic classroom QE, it’s open-ended,” Rogoff said. “You say, ‘I’m trying to create inflation of, let’s say 2 or 3 percent, and I’m going to do whatever it takes.’”

The Fed should also avoid repeating that officials are trying to boost stocks, Rogoff said, calling that a “bad idea.”

The Standard & Poor’s 500 Index tumbled 6.7 percent yesterday to 1,119.46 in New York trading, its biggest decline since December 2008. The benchmark Stoxx Europe 600 Index dropped 4.1 percent yesterday in London to 228.98, its biggest retreat since March 2009.

The Fed should have extended its asset-purchase program, “as controversial as it was,” instead of ending it, Rogoff said. The central bank completed the second round of bond buying in June, purchasing $600 billion of Treasuries.

“They need to move much more decisively,” Rogoff said.

Liquidity trap and the parodox of thrift

How to interpret the economic paralysis we're in and how to think about the options we have? Here is another pretty coherent Keynesian view.



The arguments are pretty much in line with Paul Krugman's diagnosis.

QE3 maybe the only stimulant

However imperfect, Quantitative Easing round 3 may be the only option to prevent the economy slipping back into recession.

Is US making the same economic mistakes as Japan?

Difficult times call for heroic measures. But we are not seeing much of that in the government... It's difficult to sort things out. You want to read commentaries that are at least self-consistent. Paul Krugman represents such a view, in favor of the Keynesian intervention. However, that requires a heroic adminstration and a collaborative Congress which we probably don't have.

See his prognostic for the next few years.

Does market see demand destruction?

Energy has been a good performer this year. But today energy stocks of all stripes are selling off, big time. With oil hovering above $100/b, perhaps the market is seeing potential demand destruction, not only for oil, but also for other commodities?

China's surprise trade deficit adds to the heightened uncertainty. Middle East issues are not going away anytime soon, but market will probably get used to it.

We think this is an opportunity to take some risk, especially in the energy sector.

Buffett on Stocks, Bonds and Commodities

CNBC's Squawk Box team has done a long interview with Warren Buffett. This is one of the segments I like.

Two types of assets to buy: One type of asset itself will deliver a return to you; the other type will depend on what the next guy will be willing to pay for it.

Resilient market

Despite so many headwinds including the uprising in the Middle East, market is heading up higher. Consumers are buying more. Corporations are spending more, but still not hiring.

Corrections have been shallow and short.

Why market is so resilient?

There maybe a lot of buying on dips from retail and institutional investors. There have also been a steady stream of corporate share re-purchasing.

We feel that the Fed's accommodative monetary policy is the key here. Perhaps the wealth effect is creating the crucial virtuous cycle, which eventually will reach the lagging housing market and labor market.

But inflation is becoming a threat with $100 oil and $3+ gasoline.