When the Fed announced its move to ZIRP as well as its intention to move aggressively to quantitative easing, I called it the Great Experiment. At that time I said it made me uneasy and the more I think about it and the more I read, the more queasy I become.

Though the move was greeted by a Wall Street rally, it was also met with a rather resounding collapse of the dollar. While the greenback rallied at the end of last week it has nonetheless given up most of its recovery over the past several months. Various pundits are beginning to speculate that we may be in the middle of a Treasury bond bubble. If so and that bubble deflates then things could go from bad to worse rather quickly.

I called the Fed’s move the Great Experiment simply because the idea of quantitative easing is more theory than practiced policy. It springs from the laboratories of various university economic departments and one of its main creators is none other than Ben Bernanke. In fact, quantitative easing resembles nothing more than the centuries old practice of inducing inflation in order to ignite an economy. Sort of an old idea dressed up in academic robes.

On the basis of a couple of months of negative consumer price movements (much of which is accounted for by a decline in commodity prices) the Fed has apparently decided to embark on a potentially hyper-inflationary track. Moreover, they have yet to articulate an exit plan should their program prove incendiary. All of this against the backdrop of a Congress and new administration that see the present difficulties as an opening to spend money without restraint partly to goose the economy and partly to advance some fairly controversial policy initiatives.

If foreign buyers decide that paltry returns and the risk of extreme inflation make the dollar an unattractive asset to hold we will definitely find ourselves in a sticky situation. There is a real risk of turning a bad situation into something much worse.

Further Thoughts: here