The Federal Reserve: When Doves Bribe

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No man is so foolish but he may sometimes give another good counsel, and no man so wise that he may not easily err if he takes no other counsel than his own. He that is taught only by himself has a fool for a master.
-- Hunter S. Thompson

The 24 hours leading up to the Federal Open Market Committee's (FOMC) press conference yesterday -- after which investors would learn about the Fed's plans regarding the much anticipated taper of asset purchases -- were full of nervous anticipation. The Dow Jones Industrial Average (INDEXDJX:.DJI), S&P 500 (INDEXSP:.INX), Nasdaq (INDEXNASDAQ:.IXIC), and Russell 2000 (INDEXRUSSELL:RUT) equity indices mostly started off the session with small gains before slipping ever so slightly into the red early on. The US Treasury complex -- including the CBOE Interest Rate 10-Year Treasury Note (INDEXCBOE:TNX), Treasury Yield 30 Years (INDEXCBOE:TYX), i Shares Barclays 20+ Year Treasury Bond ETF (NYSEARCA:TLT), and ProShares UltraShort 20+ Year Treasury ETF (NYSEARCA:TBT) -- also moved toward small losses while yields rose ahead of what was anticipated to be the unofficial beginning of a Federal Reserve "tightening" policy. ("Tightening" is slang used by market participants to describe the effect of reducing the lending of bank assets by making borrowing money less attractive through the increase of interest rates.)

Gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) told the story first and loudest as the "No Taper" headlines bewildered all who bothered to pay attention. These dollar-denominated commodities soared higher in the minutes before and following the announcement, raising concerns that foul play was afoot yet again via information leaked to certain traders ahead of the official dispatch. In the minutes following the announcement, there were few victory laps celebrated by those brazen enough to remain positioned for higher highs on a day trading basis, nor did we see overwhelming disdain from those who had anticipated lower prices after the size of the taper had been announced.

During a moment frozen in time, all market participants collectively agreed: This was the first "WTF?" moment we've had from the Fed in a very long time, and it came at a point in time when the Fed's credibility had never been more sterling.

Soon investors began searching for answers. Why would the Fed do this? Was this a power play? Had Ben Bernanke's god complex gone rogue? Did the Fed ever really intend to taper? The markets are perched handsomely above all-time highs and Bernanke still wants to push this unequivocal bubble higher?

It's difficult to view the Fed's actions yesterday without acknowledging the arrogance it displayed. The Fed practices great care in crafting its messages. Perhaps the loudest message yesterday was conveyed through its actions rather than its words. Is it possible the Fed is every bit as unaware of its actions today as it was five years ago this week, when the financial crisis began?

Bernanke's cute little trick, an attempt to right the wagging of the dog, couldn't have come at a worse time for his legacy; he may have just revealed that his current coordinates rest at the pinnacle of the greater fool theory . Or maybe, just maybe, he really is that far ahead of the rest of us.

Bullish or bearish, few doubt that we are now in another lar ge stock market bubble. Trend followers follow trends -- surely not all of them could believe that the economic and market fundamentals support such desperate measures by the controllers of the world's reserve currency. Certainly the FOMC couldn't believe this. Perhaps the best warning of our fate has been broadcast over the last several months by China, a country with no responsibility in reporting factual information regarding the financial health of its empire.

It wasn't long ago at all -- in fact, it was just a few months -- when "China shadow banking" was a trending topic on Twitter. The shadow banking industry is most often presented to the American public as the purveyors of payday loan schemes, offering cash to the strapped working class at interest rates that soar into the hundreds of percent per annum. In reality, shadow banking is everything from margin debt to installment payments on your pet's vet bill. Counterintuitively, if the Fed were to taper or increase interest rates, a new dilemma could form: The velocity of money (how many times currency changes hands) could actually increase dramatically.

If you've refinanced a mortgage in the last five years, you're well aware of the increase in documentation required and likely even more aware of how long, painful, and arduous the process can be. When interest rates are low, there's little incentive for banks to take any long-term risk onto their books purely for reasons of profitability and risk reward. As interest rates increase, lending standards quickly fall away as the likely rewards of lending become more advantageous through lens of probability and profitability. Of course, there's a ceiling where interest rates eventually do choke out lending and thereby shadow lending, but it's a long way away from ZIRP.

The other way to keep shadow banking at bay is by keeping interest rates so low that banks do not stimulate the velocity of money through reduced lending standards by refusing to loan money to anyone other than the most highly qualified -- the smallest subset of our economy, the ones who don't "need" the money loaned to them, but understand that using other people's money makes sense so long as it is free. If the velocity of money were to rapidly increase, the Fed would be forced to ratchet its tightening up faster and faster, stimulating hyperinflation, and impairing the Treasury's ability to issue new debt as needed for liquidity purposes (at a manageable debt service.) Meanwhile, our banks' sovereign bond holdings will inevitably plummet in value just in time for increased Basel III capital cushions, thereby causing member bank failures and noncompliance with the international secret banking cartel. (Yes, that last part is a joke; just making sure you're paying attention.)

Yesterday's decision not to taper was an admission by the Fed of poor timing. It missed the ideal window to withdraw stimulus from the American economy; it overshot. Or possibly, that was the plan. Market players are aware that the withdrawal of stimulus would likely cause another 2008-like collapse in the financial markets. Therefore, the Fed has no choice but to keep stimulus in place by means of endless liquidity while stimulating asset bubbles to the point of engineering a collapse and hoping the liquidity will exist at that time to keep the entire world financial system from going down in stride. Once on the other side of the next collapse, the Fed will have another chance to time the withdrawal of stimulus and measure the inflationary pressures of the current policies. It will also have given the rest of the world the opportunity to adjust their own fiat liquidity noose accordingly.

Or not. After all, this is an experiment.

See also:

The Federal Reserve and the Next Financial Crisis

Ben Bernanke: The Other Side of His God Complex

Back to the Races -- QEternity Lives!



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Stocks

Referenced Stocks: GLD , TBT , TLT

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