Banking on the Fed

Banking on the Fed  by Jeffry Dunyon, Editor/CEO, Safe Option Strategies

Yesterday Ben 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 already?

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.