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The Fed is Confused

Politics / Central Banks Aug 15, 2010 - 06:35 AM GMT

By: Adam_Lass


Best Financial Markets Analysis ArticleThe Federal Reserve has confused "changing nothing" for "doing nothing." The result? They are still the worst actor on Wall Street.

I was wrong.

How often are you going to see a financial columnist say THAT, eh?

But it's absolutely true. I figured that the Federal Reserve would act to prop up Wall Street by buying a billion or so in stock shares.

I didn't like the idea, mind you. In fact, I believe that this sort of active intervention on the part of our central bank is an abomination that completely distorts the psychology of the financial markets, inducing investors to buy into badly run companies in the sure knowledge that the government will repair their idiocy and fund their profits.

But in the end, the Federal Reserve chose to do nothing.

The Real Power on the Street

Well, that's not really accurate. For the past few years, the Federal Reserve has been assembling a trillion-dollar portfolio of stocks, bonds and derivatives.

It had already set the target for interbank rates at a red hair above zero, in essence inventing money from scratch and then "lending" that money for free to American banks. The idea was that the banks would mark the money up just a tiny bit and send it directly to American companies, again at almost no cost.

When that didn't serve to get the economy rolling again, the Federal Reserve began to invent and deploy "other tools." Specifically, it ginned up a second magic treasure trove of fictional dollars and simply gave it directly to Wall Street, in exchange for a veritable mountain of stocks and bonds.

Well that certainly changed the picture a bit. Over the following months, the U.S. stock market rose some 75%, a rally that only ended when the Federal Reserve stopped buying up stocks.

The Other Side of a Bad Coin

I've already mentioned one obvious catch with such interventions. The other side of that coin is that the Fed dare not intimate that things are looking up - that American companies might actually be able to turn a profit on their own - without inducing a massive sell-off.

Indeed, the slightest twitch in statement language has had an inordinate effect on stocks. Come last April, when the Fed began to hint that it might someday shut down this fountain of largesse, the financial markets reacted by collapsing some 9%, a tumble that only ended when the Fed returned to its promise of zero percent interest rates for the foreseeable future.

Which brings us to this week, with the economy neither growing nor collapsing outright, core items like houses deflating the U.S. dollar and non-core items like food gas and electricity inflating same, and stock shares stuck midway between "a steal at twice the price" and "I wouldn't touch that with a 10-foot pole."

What Comes After Limbo?

For 24 hours, the world held its collective breath while this oh-so-activist Fed board deliberated on what bold course it might chart out next, with the financial markets and the U.S. dollar rising and plunging antipodally as hints and allegations flew about.

And then, the gray men stepped forth and spoke. They conceded to the U.S. economy and financial market's stalemate, and announced that they would do... nothing.

They would not buy additional stocks, but neither would they sell the stocks they are holding as previously hinted. They would not invent more money to buy up additional federal debt, but neither would they retain the payoffs for maturing bonds, instead sending those gains back to U.S. Treasury in exchange for modest amounts of additional paper.

The gray men have attained the perfect gray-water compromise: Free marketers like myself continue to despise them for their ongoing ownership of deadbeat American companies and those companies despise them for not helping them more.

Not Heaven, That's for Sure

As I sit to write to you, investors are absolutely fleeing the financial market, trading stocks for U.S. dollars at an astounding rate, collapsing the Dow Industrials some -2.5%, and the Transports more than -4%, and the Financials -3.1%, and spiking the US Dollar Index almost 2%, all the result of Fed "inaction," or perhaps more properly said, continuation of the same ruinous actions.

I somehow doubt that this tactic will last more than 72 hours. If you were to read the FOMC's actual post meeting statement, you would note a singular footnote at the end that warns of a "technical note" to follow shortly that will address "operational details on how (the Fed) will carry out these transactions."

Now I will put my head on the block again, and make yet another prediction. Actually, it's the same prediction as I made earlier this week: When that note arrives, it will somehow contain some kind of contrived language that will allow them to stem this bleeding and funnel additional dollars to Washington's friends on Wall Street.

Maybe I'll be wrong again. It does occasionally happen.

But I doubt it.

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Source :

By Adam Lass

Adam Lass is the Senior Editor of WaveStrength Options Weekly along with Bryan Bottarelli, and a regular contributor for free financial market e-letter Taipan Daily. Adam's fascination with technical analysis started in his early days as a wholesale purchasing manager, when successfully forecasting the public's future spending habits (using Treasury reports, stock trends, interest rates, even the Farmer's Almanac) meant the difference between prosperity and failure.

He has been called “one of the most brilliant charting minds in the country.” His deep insight into the economy and value analysis enables him to reliably guide readers through today's incredibly volatile market in WaveStrength Options Weekly.

Copyright © 2010, Taipan Publishing Group

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