The Federal Reserve Bank pulled off two separate POMO(permanant open market operations) operations today for a total purchase of $13 - $18 billion worth of U.S. Treasuries. This action by the central bank has helped to inflate the stock markets higher since it was announced by the Federal Reserve Bank Chairman Ben Bernanke on August 27th, 2010. It is rather obvious that the central bank wants to keep the mood very jolly into the Christmas holiday which is on December 25th, 2010. The Fed also has a double POMO operation scheduled for tomorrow. This has been the first time that the Fed has orchestrated back to back double POMO injection days since QE-2 began.
In order for the Federal Reserve Bank's quantitative easing program to work for a while it will require the U.S. consumer to spend money. At this time U.S. consumer spending accounts for 70.0 percent of the gross domestic product(GDP) in the United States. Without the American consumer spending money this inflation rally will be a complete failure. Deflation happens for a reason and it is a real warning that something is fundamentally flawed with the current system. However, instead of letting supply and demand dictate where and how the markets will trade, the central banks artificially inflate the markets with low interest rates and the purchasing of Treasury bonds. This causes inflation and a wealth effect. The logic behind this method is once people feel better because they see their 401K's and retirement plans going up they will begin to spend more money and income. The Keynesian system that has been in place for so long can continue to function as it has for so many years.
The one problem with this theory is that every other central bank that has tried this method has been ultimately unsuccessful. Japan has been battling deflation since the late 1980's. In 1989, the Nikkei Index traded near the 40,000 level. Today the Japanese stock market index trades around the 10,000 level. This is nearly two decades of sideways to lower action in the second largest economy. What has saved the Japanese people has been the high savings rate and the low debt load by the Japanese citizens. This is just the opposite of the U.S. consumer who is still loaded with debt and has a very low savings rate. Enjoy the inflation rally while it lasts. Unfortunately nothing lasts forever.