Fed is Measuring U.S. Economic Health by the Wrong Number
Mark Twain said, “To a man with a hammer, everything looks like a nail.” To a Fed – an institution employing an army of economists and academics – everything looks like an economic problem that needs to be quantitatively eased. But the Fed is killing the economy.
Sir Alan Greenspan, who, after he left the Fed, suddenly turned into a rational and comprehensible person, was on The Charlie Rose Show in June, where he said that businesses don’t want to invest because they are concerned about the future. I agree.
Ironically, it is the Fed’s intervention in the free market and arbitrarily setting short- and long-term interest rates at insanely low levels that is responsible for this uncertainty, as it enables and propagates speculation, not investing (two distinctly different activities) and erodes confidence about the future. Usually, in investing, liquid capital is turned into illiquid by committing it to a higher, more productive long-term use. Ability (read: confidence) to forecast after-tax cash flows and discount rates (which are a function of interest rates/inflation/risk premium) is the key here. However, these concepts are foreign to speculators who are indifferent to what asset they hold (junk or quality). Their time horizon is much shorter, and they are just looking for a greater fool to unload their stuff on. The next tick in price is the only variable that matters.
Speculators are the ones driving stock prices up (and down) in the short run, but they leave as fast as they arrive. It is the investors who stick around, but because of Bernanke, they choose not to come.
Vitaliy N. Katsenelson, CFA, is Chief Investment Officer at Investment Management Associates in Denver, Colo. He is the author of The Little Book of Sideways Markets (Wiley, December 2010). To receive Vitaliy’s future articles by email, click here or read his articles here.
Investment Management Associates Inc. is a value investing firm based in Denver, Colorado. Its main focus is on growing and preserving wealth for private investors and institutions while adhering to a disciplined value investment process, as detailed in Vitaliy Katsenelson’s Active Value Investing (Wiley, 2007) book.
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