Fed Fueling Stock Market Inflation

Member Group : Lincoln Institute

The stock market has recently posted recent highs since the 2008 financial meltdown.

Inflation is allegedly tame and within "acceptable" limits.

Fact or fiction.

The Federal Reserve has engaged in monetary easing for almost 5 years now. From QE 1, to QE 2, Operation Twist, and most recently, QE 3, the central bank has infused almost $3 trillion into the monetary system.

The Fed’s efforts have been geared to kick starting the economy. When combined with massive federal deficits in excess of over $900 billion per year since 2008, this loose monetary policy when combined with an expansionary fiscal policy should normally set the stage for a significant inflation risk in an economy, particularly after 5 years.

The consumer price index for February 2013, however, shows an unadjusted inflation rate of 2% for the preceding 12 months.

With inflation allegedly under control, the Fed is continuing to pursue a loose monetary policy which is very similar to the loose monetary policy that got our nation into the housing bubble of 2005 to 2008!

The Federal Reserve is following a policy of Keynesianism 2.0 by Sundum which postulates that "…a new form of Keynesian policy, which rests on monetary rather than fiscal policy. In this approach, instead of borrowing in order to create a substitute demand, the state creates additional credit in order to restore private investment. While this might imply temporarily negative central bank interest rates, it does not require direct interventions in the private capital market by either the central bank or the government. It is argued that such an approach is both cheaper and more effective than the traditional deficit spending policy is."

As is consistent with the Fed’s own research, Sundum’s paper provides an understanding of the basis for great deal of the Fed’s monetary easing policies today.

The reality of the Fed’s actions when combined with expansionary fiscal policy is that neither fiscal nor monetary policy is effective any longer in dealing with the systemic structural issues in the Western world’s economies.

Additionally, however, the Federal Reserve’s policies are borderline negligent and irresponsible! The Fed is creating the next bubble that will make the housing bubble bursting look tame.

When interest rates have been maintained at near zero rates for over five years entire economic structures and systems/businesses become dependent upon such low rates.

The Fed’s current policies fail to reflect that economic uncertainty is preventing the expansion of the US economy not the cost of funds. Dr. Bernanke’s doctoral thesis asserts this very point about the impact of uncertainty on investment.

Uncertainty exists in many forms. At present, the uncertainty of the impact of the Affordable Care Act, the unknown impact of the Dodd-Frank bill, the impact of shrinking household incomes due to FICA increases and medical insurance costs, as well as unstable state and local governments have all combined to cause consumers and businesses to be reluctant to spend.

When there is a reluctance to spend and significant money is concurrently infused into the economy, a logical alternative is that the funds will be invested in the financial markets.

The amount of cash that is currently idle on corporate balance sheets and on the financial statements of many Americans has likely fueled this recent surge in the stock market. Rather than spend on consumables and investment due to uncertainty, money is surging into the stock market.

The net benefits of the Federal Reserve deliberately following a loose monetary policy are clear. While the net benefits may be clear, the economic downside is dangerous over the long run.

Some of the benefactors today of the monetary policy include very weak or damaged industries and governments who are able to use "cheap" funds to prolong the day of reckoning for the decades of financial neglect and overspending.

The housing market and for those homeowners underwater, the cheap interest rates promote artificially higher home prices temporarily until monetary easing is halted.

As a CPA, I have learned that for every buyer there is a seller. In other words, the good deal that exists for those beneficiaries of loose monetary policy become the victims of the bad deal when the market corrects.

Decisions are being made today due to significantly lower cost of funds that will not appear to be such great decisions in the long run.

The value of allowing an economy to correct for excesses is that it encourages people not to engage in that behavior again. When irresponsible behavior is rewarded by irresponsible actions on the part of the Federal Reserve, the stage is set for the next economic calamity.

A decline in the stock market in the United States of between 10 to 15% by the end of 2013 is very likely. This decline will be fueled by profit takers, and the eventual ending of quantitative easing by the Federal Reserve towards the end of this year.

As in the housing market all of those who benefited on the way up will now be seeking additional federal bailouts. This time, however, the sole responsibility for the disaster belongs in Washington.

Col. Frank Ryan, CPA, USMCR (Ret) and served in Iraq and briefly in Afghanistan and specializes in corporate restructuring and lectures on ethics for the state CPA societies. He has served on numerous boards of publicly traded and non-profit organizations. He can be reached at [email protected] and twitter at @fryan1951.