Tuesday, November 19, 2013

The Fed Creates 'Order' in the Markets - and Adds a Dose of Risk

 
Money and Markets
YOUR BEST SOURCE FOR THE UNBIASED MARKET COMMENTARY YOU WON'T GET FROM WALL STREET
The Fed Creates 'Order' in the Markets —
and Adds a Dose of Risk
by J.R. Crooks

Dear Friend,

xxxxx

The Federal Reserve has brought order to the global financial system. And that order has given impressive gains to investors. The S&P 500 Index, for example, has risen more than 140% since the Fed first stepped in to offer its support.

But unfortunately, order doesn't bode well for the future of the financial system — financial markets included.

Consider that the 140% rise in the S&P 500 was without a subsequent improvement in the U.S. economy. No substantive gains have been made.

[Editor's note: Tune in tomorrow for a discussion on U.S. growth prospects.]

Consider also that the number of initial public offerings (IPOs) this year are the most since the dot-com bubble; borrowing to pay for stock purchases is higher than it's ever been; and the 20% rise in corporate stock buybacks are juicing share prices for all the wrong reasons.

In other words: The improvement in financial markets has not been about stimulating the real economy but instead about managing perceptions. And the Fed has decided that is best accomplished by creating order in the financial system.

But if you understand the dynamics of ordered and disordered systems, what the Fed has done is create an unnecessarily fragile financial system. Listen ...

A highly ordered system is an overly complex system. The perceived need to create order is based on the perceived need to actively fix a problem. Thus, a highly ordered system must become overly complex as more and more moving parts "must" be added or engineered.

And an overly complex system is a fragile system. The more and more moving parts needed for a system to function properly, the greater the likelihood a small malfunction in one part will render the entire system impaired.

Basically, a highly ordered financial system is a fragile financial system.

Think about what Federal Reserve chairman-to-be, Janet Yellen, said recently in a response to a question about monetary policy potentially generating asset bubbles:

"As a first line of defense, we have a variety of supervisory tools, micro- and macro-prudential, that we can use to attempt to limit the behavior that is giving rise to those asset price misalignments."

On the one hand, she acknowledges the rumors of asset-price misalignments. On the other, she tries to be reassuring about the Fed's ability to maintain order. Her vagueness about how the Fed might maintain order has been described by CounterPunch.org as similar to her predecessors' "circuitous, jargon-laden koans and pompous-sounding gibberish to conceal the Central Bank's real agenda."

Can you blame her?

She made a very brief note about the importance of "financial stability." But no way will she disclose the truth about where the Fed's efforts are squarely aimed. (Hint: The financial economy.)

If the general public catches a whiff of what "financial stability" has and hasn't meant, then the Fed's goal of managing perceptions will quickly be squandered.

Financial stability hasn't meant economic growth. It never could.

Financial stability has meant a windfall of subsidies, backstops and perks for financial institutions and Wall Street. And it has meant the creation of a fragile financial system.

It means rising asset prices are increasingly vulnerable to spontaneous collapse from a financial system seizure. The reverse is also true: The financial system is increasingly vulnerable to a spontaneous collapse from seizing asset prices.

Keep asking yourself: At these levels, are stocks worth the risk?

Best,

JR

P.S. Throughout this week, my Money and Markets colleagues and I will take to the Money and Markets blog to ask a "Question of the Day" in preparation for our special year-end online conference.

Knowing what you're concerned about and the opportunities you're most excited about will go a long way towards helping us make sure we cover the areas that will help you most.

Today, we're looking for your thoughts on the end of quantitative easing:

Will the Fed end its money printing and bond buying scheme in 2014?

If so, how will the end of QE-Infinity impact the U.S. economy and stock market?

Participating is easy: Just click this link to go to the blog, then scroll down and use the handy comment area to join the discussion!

Have comments? Tell Us!

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