Fed Acts - Likes Rising Stock Prices

Posted by urbandigs

Thu Nov 4th, 2010 10:04 AM

A: 'Asset price inflation' is what the fed is hoping for, and it seems to be working. Its nice to know that when underlying fundamentals and market forces signal one thing, the fed can simply come in and re-engineer the environment to something else. What we have here is a continuation of a fed-engineered bank recapitalization environment, where a steep yield curve will help banks profits and wall street will push money towards anything risky that offers higher yield. Crazy times indeed.

Bernanke's Op-Ed in The Washington Post says it all, "What the Fed did and why: supporting the recovery and sustaining price stability":

The FOMC intends to buy an additional $600 billion of longer-term Treasury securities by mid-2011 and will continue to reinvest repayments of principal on its holdings of securities, as it has been doing since August.

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will further support economic expansion.
The reason hyperinflationists have it wrong is because they think this money printing fed is dumping '100 dollar bills' onto the streets for all of us to pick up and spend! Not so. Instead, the fed is buying assets from Primary Dealers at the POMO desk of the NY Fed, buying these assets with funds that didnt exist before. Its called monetizing the debt - as the government is issuing the debt (treasuries) to finance operations and the fed is then buying these assets with a mouse click via Permanent Open Market Operations. The money is being hoarded by banks and money centers in excess reserves, and its not being lent out and multiplied (think credit creation) by our fractional reserve fiat based system. This is why hyperinflationists have it wrong, why credit creation is non-existent, and why money is simply not sloshing through our main street economy.

Here is a chart showing Excess Reserves of Depository Institutions, with just under $1,000,000,000,000.00 hanging around:


The fed is trying to reflate asset prices, so we can grow our way back to prosperity that way, and engineer an environment where banks can recapitalize and carry trade their bad assets away. Period. Wall street is riding it BIG TIME and all this liquidity is looking for higher yielding assets. There will definitely be new bubbles blown and future bubbles burst as an unintended consequence of these policy actions to stem deflationary pressures. In meantime, consumers continue to delever and pay down debt while businesses that can, are scrambling to raise new capital. The party goes on until it doesn't. My concerns are commodity inflation that crunches wallets/margins and ultimately, what happens when the masses take a rush for the exits. Who will be holding the bag when the music stops?? In the meantime, all the stuff that we need to live and the metals will see higher momentum at a time when unemployment is high and debt levels still a burden.