The View From 1776
Friday, February 07, 2014
Fed Follies In A Nutshell
Quote from a Barron’s (subscription required) article by Francois Sicart, A Bottom-Up Investor Considers the Top Down
It all started under the U.S. Federal Reserve chairmanship of Alan Greenspan, when leading economists and central bankers adopted the notion that consumers’ net worth is what drives consumption, and more generally the whole economy. Since the two main components of a consumer’s net worth are home values and stock and bond portfolios, it became customary, at the first sign of an economic slowdown, for the Fed to intervene to boost these assets. This was done, directly or indirectly, by injecting liquidity into the banking system (to make home mortgages cheaper) and into the financial markets (to encourage discretionary spending by making investors feel richer).
Soon, however, it was no longer deemed necessary to wait for an economic slowdown. In what became known as the “Greenspan Put,” the Fed began to intervene without waiting for actual economic deterioration; i.e., whenever a stock market correction became somewhat worrisome. Not surprisingly, investors progressively convinced themselves that no major bear market in stocks or bonds could occur under the Fed’s watch, and eventually widespread complacency became “irrational exuberance.”
Liquidity, a concept that heretofore had been used mostly by relatively obscure technical analysts to predict short-term fluctuations in the stock markets, has become for the last several years the main driver, and therefore the most keenly watched indicator, not only of these markets, but also of the global economies.
The Fed’s Greenspan-Put perspective ignores the distorting effect of excessively loose monetary policy on personal savings and corporate investment, the two essentials for long-term, stable growth in the economy.