The Economic Circus: Understanding the Federal Reserve’s Role

Understanding the dynamics of economic policies and their impacts can be perplexing. While some individuals seem destined to repeat the same mistakes, others navigate these complexities with caution. Whether it’s a clumsy worker with a hammer or an overzealous professor steering the Federal Reserve’s monetary policy, the results can often be detrimental. This article explores the current economic climate and critiques the actions of the Federal Reserve, particularly under the leadership of Ben Bernanke.

Creating money out of thin air seems like an appealing profession, especially in prosperous times. A Federal Reserve Chairman often appears to play a masterful role during such periods. However, when economic downturns strike, the truth becomes evident: central bankers can sometimes be more harmful than helpful.

As of the first half of 2011, economic growth was a mere 0.7 percent. After accounting for inflation, it’s clear that the economy is not progressing, but rather regressing. Many individuals are feeling the financial pinch.

Recently, we saw a significant drop in the Consumer Confidence Index for August, plunging by 14.7 points—or nearly 25 percent—to a low of 44.5. This marks the lowest level of consumer confidence since April 2009, a time when the economy was officially in recession.

Over the past week, stock markets have exhibited a pattern that, at first glance, might suggest good news for investors. Despite a 120-point selloff yesterday, stocks generally moved upward following a brief drop below the 11,000 mark earlier last week. In fact, even after recent losses, the DOW remains up by 571 points.

It’s evident that the economy lacks substantial backing for this stock market climb. Paradoxically, bad economic news tends to fuel optimism in the stock market, as it increases the likelihood of further monetary stimulus. Especially with a jittery figure at the helm of monetary policy, the prospect of more “funny money” has investors buzzing.

Market Sentiments and Strategies

A well-known saying on Wall Street is, “buy the rumor, sell the news.” While the phrase may seem vague, it often implies that investors should act on potential developments before they materialize. As soon as a rumor becomes fact, the opportunity may have already passed.

This week, speculation surrounding Ben Bernanke’s interest in purchasing Treasuries has been prevalent. According to the minutes from the Fed’s August 9 meeting released on Tuesday, discussions are underway about increasing government debt purchases. Wall Street believes this could significantly benefit the stock market.

Looking back to the initial buzz about QE2, announced by Bernanke at the Jackson Hole retreat on August 27, 2010, it’s worth noting that the DOW stood at 9,985 that day. By the time QE2 was officially implemented on November 3, the DOW had climbed to 10,789—an 8 percent increase solely based on speculation.

The DOW peaked at 12,810 on April 29, 2011. For those who followed the adage “sell in May and go away,” their timing may have been fortuitous, allowing them to avoid this summer’s significant downturn.

With a glance back at the past, we must now turn our gaze to the future. What implications does Bernanke’s latest talk hold for the stock market?

While we cannot predict how it will affect stock valuations, we have some insights regarding its economic consequences…

Inflation and Market Intervention

For one, increased asset purchases by the Federal Reserve will likely do little for the economy, serving only as a temporary solution to a much larger issue. But what use is life support when the economy is already in a coma?

Despite the trillions of dollars injected into the system, it remains unresponsive. Yet, as previously mentioned, some individuals never seem to learn. In Bernanke’s case, he appears more inclined to devalue currency than allow markets to self-correct, boosting the economy with artificial monetary stimulus rather than letting it adapt to reality.

Before this year concludes, expect the Federal Reserve to introduce yet another questionable initiative. They will likely market it as being for the common good.

However, what more can they possibly achieve than what they’ve already implemented? Their actions seem limited to inflating the money supply and skewing credit markets.

Following the backlash against quantitative easing during QE2, when it became clear that it relied heavily on traditional money printing, the Fed may opt for a different terminology—such as interest rate capping.

Interest rate capping is undoubtedly an extreme form of governmental interference in market operations. Essentially, it constitutes price controls, as it fixes the cost of borrowing money.

As noted by author and publisher Gary North, over half a century ago, Senator Wallace Bennett equated price controls to applying adhesive tape to control diarrhea.

Keep this analogy in mind when the next grand Fed initiative is announced to save the economy.

Sincerely,

MN Gordon
for Economic Prism

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