The Last Match

In Jack London’s short story, To Build a Fire, an Alaska prospector breaks through the ice of a frozen creek in the middle of winter, then finds he has only a few dry matches left to start a fire. The suspense builds as each match flickers out before a fire can catch. His fingers begin to freeze. Desperate, he tries to kill his dog so he can warm his hands by plunging them into the animal’s steaming guts. But it’s too late: his hands are frozen. He can’t even handle his knife. Finally, as hypothermia overcomes him, he sits down in the snow to die.

Fed Chairman Alan Greenspan’s situation isn’t quite as dire as London’s prospector. But with its latest rate cut on Wednesday, the Fed is almost down to its last match – at least as far as conventional monetary policy is concerned. Like the prospector, the chairman may soon have to consider the unconventional.

Don’t be surprised if someday soon you see Greenspan down at the D.C. dog pound, picking out a stray.

At 1%, the key Federal Funds rate isn’t just at its lowest point in 45 years – it’s also approaching the non-negotiable limit of how low the Fed can take it. Much lower, and money market funds, where most people keep their spare cash these days, won’t be able to cover their expenses – resulting in negative money fund yields. At that point, savers literally would be better off sticking their cash under their mattress.

Since money funds now constitutes a parallel, lightly regulated banking system – one that contains over $2 trillion in assets – encouraging depositors . . . cough . . . shareholders to pull their money out en masse probably isn’t the kind of behavior Chairman Greenspan wants to encourage right now. And if rates go lower still, the Fed will start mucking up the repo (short for repurchase agreement) market, where large financial institutions and corporations like to stash their spare cash.

What kind of effect could that have on the financial system? Well, imagine draining all the oil from your crankcase, and then trying to drive across town – doing 80 mph on the freeway. Now imagine what that would do to your engine.

So the Fed has maybe one more match left in the box – and it’s an itty bitty little paper match, the kind with the heads that are just as likely to break off as ignite.
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