Banking on the Fed by Jeffry Dunyon,
Editor/CEO, Safe Option Strategies
Bernanke announced a timeline for the tapering of the Fed’s stimulus based on
certain economic projections. The ongoing stimulus is the purchasing of
assets which primarily involves bonds. Immediately following the
announcement the major markets seemed to jump off a small cliff. Maybe
not the kind of drop that could spur a panic of Black Monday proportions, but
certainly enough of a panic to cause more than one day trader to pucker up and
punch a new computer monitor. After seeing 15,318 early in the day, the
DOW took a sharp turn around 2:50 Eastern Time and ended the day at 15,130, a
drop of more than 188 points from its high, which was very close to the
previous days close. Add to this the 200 point drop at the open of
today’s market, and you have what some investors are already calling the
beginning of a sizable, if not major correction. While it is yet to be
seen if today finishes down, or if the week ends on a bearish note, we have
already seen that the Fed’s plan to taper is seen as a reason to sell.
So, why the panic? Why choose to sell over good new? Isn’t the
Fed’s decision to taper based on economic forecasting of good, not bad news?
Hasn’t the Fed printed enough money and devalued our currency enough
I believe the first answer to these questions is simple: Most people do
not fully understand (or even partially understand) what the Fed does.
Here are a couple of things I believe most people do not know, or do not want
to know about the Federal Reserve: 1) When it was created, the Federal
Reserve’s only three mandates were: Maximum Employment (something that
most people, including myself still do not completely understand); 2) Stable
Prices; and 3) Moderate Long-term Interest Rates. That was it. But,
since its creation in 1913 its role has significantly expanded. Things
like “conducting the nation’s monetary policy” have been added. Other
expansions include “providing financial services (i.e. loaning money) to
depository institutions, the U.S. government, and foreign official institutions
(that last one it code for the UN)”, etc. The expansion has been
significant and that was evidenced yesterday by the drop in the markets on the
heels of the Chairman’s comments.
A greater or broadened understanding of what the Fed does may help someone
understand how a Ben Bernanke announcement could move the markets, but it still
doesn’t answer why the specific announcement yesterday would cause a sell off.
Well, here is some further Fed education for those who may not know:
The Fed makes money when it loans money at 6% interest and when its borrowers
pay back the money. That’s a good thing, right? WRONG! When
the number one borrower from the Fed is the US government (who, let’s be
honest, doesn’t have the best spending habits to begin with), and any interest
the U.S. government is paying back to the Fed is tax money, how is it a good
thing that the Fed makes money? It’s nothing more than a redistribution
of our money from one government entity to another. Interest paid by the
U.S. government, to the Fed, increases the deficit and therefore the national
debt. That is not a good thing, and you do not need a degree in
economics, nor do you need to be on a certain side of the political isle to
understand it. Debt is not good. Deficit spending is not good.
In 2010 the Fed made $82 billion dollars profit and a majority of that
came from the U.S. government. In 2011 the amount was similar. They
may say profit, but I call it debt.
The Fed spent far more money each of the past several years on purchasing
assets for purposes of stimulating the economy. That’s one of its
mandates, remember? “Conducting the Nation’s monetary policy.” So, if the
Fed is in the lending business, and it spent far more than it made, where did
the extra money come from? Who did the Fed borrow from? This is the
question many financial talking heads could answer, but won’t. Or, if
they will answer this question, the viewers do not want to hear it. Or,
ideology gets in the way of a willingness to listen and exercise some common
sense. The answer to the question is that the Fed doesn’t borrow money,
it prints it. Every time the Fed spends more money than it brings in, it
prints the extra money it needs. Every time the Fed prints more money,
every single dollar in circulation, by way of the added dollars the Fed puts
into circulation, lessens in value. Again, this does not take an advanced
financial degree to understand. More printed currency added to the
economy devalues all the currency in the economy. A devalued U.S. dollar
is not a good thing.
Now bring this all back to the drop in the market today and yesterday, because
there is a second answer to “why the sell off?”. Why is the Fed’s plan to
taper the purchasing of assets for the purpose of stimulating the economy a bad
thing? You might come to the same conclusion as me if you ask the
question in a different way. ‘Why is the Fed’s tapering of 1) adding to
our deficit spending and our debt, and 2) devaluing the dollar, perceived as a
bad thing by the investment community at large? ‘ Why is the economy’s
improvement (which is the forecast the Fed is basing its tapering decision on)
a bad thing, or put more into trading terms, a reason to sell?
I believe the second answer lies in the shift of thinking found in many
Americans and many investors, that the government should fix our problems.
Now, this answer is going to rile a lot of conservatives (and please
understand that the purpose of this article is not political), and is going to
offend a lot of liberals. Well, that just too bad. It’s the truth.
Even the capitalist who dominate the investment community have come to
believe in large part that the government should provide solutions to our
problems. What other mindset could explain why the Fed doing a good
thing, is perceived by investors as a bad thing? It takes the same
mentality that believes getting people off welfare by taking it from them and
forcing them to get work is a bad thing, to believe the Fed weaning of stimulus
money is bad.
Look, I know there are other things at play here, and I readily acknowledge
that this is my opinion. But, let’s get real; get our heads out of the
sand; get our common sense back, and recognize that the Fed’s suggestion of an
improving economy could allow them to do a good thing sooner than otherwise
planned…..is a good thing! Selling off in the face of good news……not
a good thing.