You can’t deny it, the Fed’s 2009 to present intervention into the markets has accomplished exactly what they intended, or at least seems to have done so. The question of course is, how will the markets fair as the captain slowly puts the autopilot back on.
As seen in the chart above the US Dollar and gold have been held firm in a sideways trading pattern since 2012 and 2013 respectively. The equity market has seen substantial gain, roughly 35% since the Dollar began it’s consolidation and Gold took it’s dive from the $1900’s. Real Estate indexes also show a leveling off with a slight favor towards the up side. Rumors for months that the QE3 program would finally come to an end around October and monthly repurchasing declining from $85bn down to around $35bn per month all seem like good things. We were even told that interest rates may be allowed to advance starting as early as 2015, although I think most believe it will be later than that.
When you draw yourself a bath, the water keeps running for a while, keeps it warm and moving. Flowing water seems cleaner than stagnant. Eventually you have to turn the water off. The reality is, prior to the recession and the 2009 QE plan, the Fed owned roughly $750bn in treasuries and mortgage-backed securities, today, they own over $4tn(source). That seems like a lot of bath water.
If Keynesian theory tells us that wealth can neither be created nor destroyed, but only change hands, then where is the wealth shift coming out of to cause such substantial growth in the equities without causing comparable declines in other markets? Clearly much of the QE program has helped to stabilize both the real estate markets through the MBS programs as well as influence Wall Street investing. Also, artificially low lending rates encouraged borrowing from consumers which aided in refinancing and leveraged investing, but discouraged that same group from the traditional retirees best friends, fixed assets and annuities.
Why equities? There are other assets, as seen lower lending rates should encourage refinancing and possibly even new home purchases. However, with the scars from the previous debacle years ago still rather fresh in most peoples minds, it is reasonable we have not seen much of that speculative free currency heading that direction. The question arises however, are we seeing the makings of an equity boom to bust similar to what we’ve seen previously in real estate and tech stocks?
With no major movement in alternatives to equities, up or down, I would anticipate a short term loss in both the US Dollar and commodity values along side the initial stages of an equity blow-off. This initial sell-off usually to cover margin calls, getting rid of good assets to pay for the bad ones. This is likely followed by above average increases in the US Dollar and substantial increases in alternatives like gold and foreign currencies as the average investor finds footing after the fall and seeks cover from the possibly impending storm. Since both the USD and commodities like gold have already taken their corrections, I anticipate their declines to be short lived.
On a Personal Note
I’ve always felt that Ben Bernanke’s entire career was spent trying to prove his PhD thesis. I suppose there are far worse ways to spend a life, and he has had the opportunity to use the greatest financial tools in the history of our world to do so. But now we are moving into the 11th hour. If the actions from Bernanke to Yellen manage to stabilize markets going forward, then he will consider himself a success. If they are able to step back the Fed easing programs, release interest rates back into the wild, and face minimal consequences, then I tip my hat to the Keynesians. They will, to a large extent, have been correct in their own abilities, and I am a humble enough man to acknowledge that. However, we cannot forget that in the Keynesian quiver, there are only two arrows, money printing and interest rates. While the men and women at the Fed and in Washington can tell themselves financial decisions are made in the vacuum of logic and calculation, in reality the men and women on the street are an emotional mob, chasing in greed or fleeing in fear. Sometimes even frozen in indecision. If you have never read the book, Extraordinary Popular Delusions and the Madness of Crowds, pick a copy up at your local bookstore or online.
Let us also not forget the Fed Government, an animal more rampant than the civilian mob. We have not discussed government spending, which is the reason why the Fed must continue its policies, to some extent indefinitely. A retired investor may want interest rates to rise, allowing their life savings to be invested in safe, fixed assets. But an over-extended government needs our interest rates to remain low, allowing them to borrow those life savings at sustainable levels.
As someone who sides with free market, Austrian Economic thought, it’s simple to want to kick the maestro and his Keynesian followers, akin to Catholics fighting Protestants, or warring native tribes while the Europeans are landing on the shores. But the reality is, the Fed has been a financial parent with a limp wrist and a long leash, and government spending has been the unruly 6 year old boy on caffeine. Although a mob, I believe the people, the banks, the investment firms, the insurance companies, the free market will learn to adjust their living or find new loopholes under a less intrusive Fed. My fear is will the government, who’s main job is to remain in office, be able to appease the mob AND live within the same financial guidelines?