Global Agenda: Don’t fight the Fed?

The old adage is being openly questioned in Wall Street itself, where it originated, and has been turned on its head in Main Street.

By PINCHAS LANDAU
A long-standing adage on Wall Street warns traders: “Don’t fight the Fed” – meaning, don’t take a position that flies in the face of current monetary policy, as announced and implemented by the Federal Reserve, the US central bank.
Rarely has the Fed’s policy been so clearly articulated as it is today: Fed Chairman Ben Bernanke has stated in the plainest terms that he wants to push the rate of inflation UP, because he fears that the economy is, or might soon be, slipping into deflation. He wants to stimulate spending and investment, to which end he is prepared to pump very large amounts of money into the economy via purchases of US Treasury bonds, so that interest rates will fall even further for medium- and long-term loans (short-term interest rates are already close to the lower limit of zero). He considers higher stock prices necessary to foster a “wealth effect,” which will encourage people to go out and spend, thereby pushing the consumptionheavy American economy out of its rut and back onto the high road.
You couldn’t hope for a clearer set of guidelines than that. The Fed is telling you to buy bonds – because it will buy bonds, so their prices will rise. Buy shares – because there will be lots of liquidity and low interest rates, so what else is there to do? Shares are an explicit target, but they are also implicitly recommended as a protection against inflation, which is going to rise according to the Fed. But so are precious metals and commodities in general, because they are the stuff from which inflation is made, so they are also a good buy.
Since Bernanke’s polices are also designed to weaken the dollar – although he cannot and must not admit that – it follows that selling the dollar and buying other currencies is also an implicit recommendation of the Fed.
It is quite apparent that many people have followed these guidelines and, by aligning themselves with the Fed, participated in and even caused the surge in prices that has taken place in recent months in equity markets and in commodity markets. However, it is also apparent that not everyone has swallowed this line of thinking.
Indeed, it seems that there are many investors who have chosen to fight the Fed very directly – and, so far at least, have profited by doing so.
These include investors in the currency markets – where the dollar hit bottom on the day following the Fed announcement of the details of its latest $600 billion bond-buying foray and has been in an uptrend ever since – as well as investors in the bond markets. Bond prices rose sharply in the period between the general announcement of the new policy, in August, and the detailed announcement and move to implementation in early November. Since then, bond prices have fallen sharply, rebounded somewhat and then fallen again.
It is a basic fact of the financial world that the currency market is by far the biggest of all financial markets, the bond market is much bigger than the equity market, and the commodity markets are much the smallest – in terms of the amount of money passing through them on an average day. In other words, in the biggest markets, the majority of investors (or at least those with the most money) have chosen to fight the Fed and – again, so far – are winning.
The idea of the markets as a democratic mechanism of expressing opinions and actually taking a stand with regard to specific polices or the overall direction of policy is well-established. But there has been a more orthodox democratic process as well: namely, the mid-term elections, in which the anti-Fed forces – in the inchoate shape of the “Tea Party” – have won a major victory.
These new members of Congress, especially those of the new Republican majority in the House of Representatives, come with a very clear mandate to expressly fight the Fed. Their leaders intend to do so at every opportunity, and the new session just begun will provide many such opportunities.
They also intend, of course, to fight the president and his policies, including the reforms he has succeeded in pushing through in the first half of his term. That is the more obvious and natural fight, in the context of a two-party system. But the fight – more correctly, the openly declared war – on the Federal Reserve, its policies and even (among the extremists, of whom there are not a few) its very existence, is a new departure in American politics.
Ironically, these extreme Republicans have allies overseas, in places such as Beijing, where the leadership views the inflationary and devaluationary policy being pursued by Bernanke as injurious to the Chinese economy, and in a slew of South American countries, where reasons to dislike America and its policies are always being sought and, in this case, easily and justifiably identified.
In short, the old nostrum of “Don’t fight the Fed” is being openly questioned in Wall Street itself, where it originated, and has been turned on its head in Main Street, where fighting the Fed is increasingly viewed as either a patriotic duty or a necessary act of economic survival.
This war is already – and will surely remain – the primary issue in the American economy in 2011.
landaup@netvision.net.il