It was always folly to believe that inflating asset bubbles could solve the structural problems of a post-industrial economy.

The Doomsday Scenario for the stock and housing bubbles is simple: the Fed’s magic fails. When dropping interest rates to zero and flooding the financial sector with loose money fail to ignite the economy and reflate the deflating bubbles, punters will realize the Fed’s magic only worked the first three times: three bubbles and the game is over.

So what happens when punters realize there won’t be a fourth bubble? They sell. Bids disappear because who’s dumb enough to bet (with Japan and Europe as lessons) that more liquidity and negative interest rates will magically work when zero interest rates didn’t move the needle?

Who’s foolish enough to catch the falling knife (i.e. buying plummeting assets on the way down) on the unsupported assumption that the next dose of Fed magic will reverse a bidless market? Why Our Status Quo Fai... Charles Hugh Smith Best Price: $4.31 Buy New $6.45 (as of 07:30 UTC - Details)

And should the Fed start buying stocks, mortgages, housing and bonds to prop up those bidless markets, what’s the message it will be sending? Desperation.If the only buyer is the money-printing central bank, that’s pretty good evidence that your economy and markets are in free-fall.

The loss of faith in central bank magic will be gradual at first, as magical thinking dies hard. It’s oh so comforting to believe the central bank will rescue every overleveraged mal-investment and bail out every high-risk speculation, but the funny thing about the Fed’s magic is it only works in liquidity crises–in every other condition, it only makes matters worse.

Does making it cheap to borrow improve the productivity of capital investments? You must be joking. The poster child of Fed magic is corporate buybacks, which 1) create no goods 2) create no services 3) do nothing to improve real wealth creation, i.e. higher productivity and 4) burden the company with higher debt loads, inhibiting future capital investment in actual productive capacity. Get a Job, Build a Rea... Smith, Charles Hugh Buy New $6.95 (as of 04:50 UTC - Details)

The only thing stock buybacks accomplish is to enrich shareholders and top managers with stock options. Rather than fix what’s broken in the economy, the Fed’s plan of “make the already-wealthy even wealthier” has created a new and monstrous problem: soaring wealth inequality.

The Fed’s idea of a solution was to triple the value of a small bungalow from $150,000 in the late 90s to $450,000 in 2007. When that bubble burst, the Fed’s solution was to double the bungalow’s value to $900,000 today.

The structural problems of the U.S. economy cannot be solved by inflating asset bubbles, but that’s all the Fed can do. Ironically, everyone cheering on Fed dovishness today is writing the obituary of Fed influence going forward because the masses have awakening to the Fed’s role and the political blowback against enriching the already-rich is going to blow away the Fed’s political leeway to further enrich the already-rich.

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The Best of Charles Hugh Smith

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