Federal Reserve And Market Risk

FEDERAL RESERVE AND MARKET RISK

Analysis and opinions of the financial markets vary depending on who is doing the analyzing. The most critical element that affects the song is the singer.

There is nothing wrong with that. But we should be aware that our own prejudice clouds our perspective. However, there is more that is not so obvious. With that in mind, lets take a look at things.

Today, more than ever before (at least it seems that way), focus is on the Federal Reserve. Even economists and the general public have joined the throngs of interested observers.

Stocks and bonds fell significantly over the past several days, partly in response to statements by Chairman Powell. The Chairman’s remarks indicated the intention of the Fed to continue its push to raise interest rates more aggressively, and without seeming regard to any deleterious effects on the economy and the stock market.

So, we hear criticism that the Fed is guilty of policy error. “The Fed needs to be more accommodative at this time.” Maybe; maybe not.

Not too long ago, people were complaining that the Federal Reserve was not acting decisively enough.

Part of the problem is seeing the entire situation for what it is – and not for what we think it is, or want it to be.

Inflation and low-interest rate policies were slow in stimulating the desired results.

Similar the repeated doses of a drug addict, each succeeding monetary fix is less and less effective.  The fixes, at best, allow the patient (i.e. the economy) to sustain life temporarily. And with each passing day, the possibility of slipping into a coma (recession, depression, etc) increases.

Continuing down the path of artificially low interest rates and ultra-cheap credit would eventually kill the U.S. dollar. The Fed knows this.

Their decision a few years ago to begin raising rates slowly was an attempt to begin a return to a more normal level of economic activity with interest rates at more reasonably normal levels.

Unfortunately, this action has its own serious risks. Easy credit and low interest rates are the new normal. Attempts to generate higher rates from abnormally low levels creates additional strain on an economic system that is already quite fragile. As bad as cheap credit can be on a fundamental basis, the effects of withdrawl from it can be just as bad. (The Fed knows this, too.)

Stocks, bonds, and real estate all benefited from cheap and easy credit. The ‘reflation’ effort was the primary reason that asset prices rose so dramatically from their post-crash lows ten years ago.

In other words, all asset prices are severely and artificially overblown. Another credit collapse is likely in the cards. And nothing will be spared.

Also, the Fed’s balance sheet is swollen. Their attempts to unload a bloated inventory will add fuel to the fire.

The Fed has three options: 1) continue their pursuit of higher interest rates 2) return to a more accommodative policy of cheap credit 3) try to steer a course between no. 1 and no. 2.

No. 3 is what they have been doing until more recently. No. 1 will be followed until the patient screams too loudly, or a full-scale collapse occurs. Then we will likely see a return to No. 2. Unfortunately, it will be too late.

Any efforts by the Fed to halt or recover from economic calamity will be ineffective.   Fundamental laws of economics cannot be abused and ignored indefinitely.

Don’t expect the Fed to deliver you. They caused the Depression of the 1930s and the credit collapse in 2008. Their policies and actions have brought us directly to our current predicament.

 

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!