Historically the market has boomed after Federal Funds rate cuts.  The ease of finding low rate credit makes its way to financial markets, serving up a boom period every time rates are lowered.  This time, no matter how low rates are going, the markets are not responding.

The credit crunch is still underway.  While the Federal Funds rate is approaching new lows, there is still mal-investment to be taken out of the system.  A recession is a normal part of the business cycle, the market moves to expel any unnecessary credit.  The last few months of price action is housing and in corporations can be seen as this removal of credit.

In the past, lowering the rate and opening up the Reserves to more money would create more new credit than was disappearing.   While this does produce short term inflation, it would also boost confidence until the money supply could then be deflated later.

Unfortunately the money supply has not been deflated since 1929, the last great depression.  Almost all depressions are created from a contracting money supply, the Federal Government knows this and will do anything in its power to avoid it.  The real problem isn’t in the current M0 money supply of $900 Billion, its in the M3 supply of over $10 Trillion.

While just $900 Billion in hard currency is in print, $10Trillion exists in the form of credit and loans.  Just simple mathematics will tell you that the amount of credit is ten times higher than the actual amount of cash.  It is natural for a market to try to correct to its actual value, the last 10 years is full of too much credit resulting from housing and loans against the inflated value of homes.

The Federal Reserve has the tough job of keeping the money supply at the same number to thwart of deflation and keep inflation worries away.  If the market doesn’t respond to this next half-point cut, chances are that we’re not going to see a rebound any time soon.