These days, it doesn’t take much selling to growl up a thunderous roar for help. The DOW’s fallen 1,258 from its May 1 interim high of 13,359 and, judging by the headlines, the next great market panic’s upon us. For whatever reason, not only is the Fed responsible for managing the nation’s money supply and supporting full employment, the Fed’s also responsible for ensuring the stock market always goes up…
“Federal Reserve Chairman Ben Bernanke will be back on Capitol Hill on Thursday to testify before a congressional committee about the state of the U.S. economy,” reports Reuters. “He’s not going to get an easy ride.
“The blue-chip Dow average (.DJI) of stocks is now negative for the year. Employment appears to be slowing to a snail’s pace and Europe remains mired in crisis.
‘“This puts the Fed firmly in play and they will likely feel compelled to respond,’ said Tom Porcelli, chief U.S. economist at RBC Capital Markets in New York, after data on Friday showed U.S. job growth in May was the weakest in a year.
‘“The missing ingredient preventing the Fed from action had been the equity market, but now we are seeing it softening,’ he said. “Equities are falling and that was the last hurdle for Fed policy action because all the other criteria have been met.’”
If you can believe it, the fact that stock prices are falling gives the Fed cover to intervene in capital markets. But why?
Wanting to Love Free Markets
Everyone wants to love free markets. Their benefits are often cheered by politicians, leaders, academics, and frauds of all political stripes. But, by our observation, free markets are only loved some of the time. Namely, when everyone’s getting rich.
When all that’s required to get rich is to buy an index fund and a house, sit back, and watch their value go up year after year…everyone loves free markets. Fools get rich. Politicians get reelected. And consumers cash out their inflated equity to buy stuff – lots of it.
When free markets are exposing malinvestment and imprudence with exacting precision, people no longer love them. They despise them. Fools go broke. Politicians get booted out of office. And consumers drowned in their debt.
When free markets purge the rot from the financial system – and the economy – everyone wants bailouts, market intervention, and, most of all, they want stimulus. But, just what the heck is stimulus anyway?
Monetary stimulus, that is stimulus originating from the Fed, is currency debasement. By fixing the price of credit and flooding financial markets with an abundance of cheap money, the Fed weakens the dollar. Regrettably, creating a profusion of dollars has the ill effect of cheapening the value of each dollar in existence. Overtime this robs wealth from savers and retirees living off the fruits of a lifetime of work.
In the short term, currency debasement appears to be a simple solution to the debt problem. Ultimately, policies of inflation slip beyond the reach of those tasked with managing the money supply…
Stimulus and Spasmodic Economics
At first, the stimulus appears to improve the economy. Business activity picks up, unemployment goes down, and the stock market goes up. But once the phony money makes its way through the system it leaves the economy on shakier ground than it was before. Thus, evermore stimulus is needed just to keep things from backsliding.
Alas, this is the unfortunate position most western economies, including the U.S., now find themselves. Yet it is in no way unique. In fact, it has happened many times throughout history. One notorious occurrence was during the French Revolution…
“In spite of all the paper issues, commercial activity grew more and more spasmodic,” explained Andrew Dixon White in his classic work, Fiat Money Inflation In France. “Enterprise was chilled and business became more and more stagnant.
“The plenty of currency had at first stimulated production and created a great activity in manufacturers, but soon the markets were glutted and the demand was diminished.”
Each downturn in France’s economy was countered with evermore issuances of paper money, until the populace lost all confidence in the currency. Between 1790 and 1795 the price of flour increased 11,250 percent…and all other prices increased by a comparable amount. By 1797 France’s currency was worthless and its economy in shambles.
Perhaps drawing parallels from the French experiment is for simpletons. Nonetheless, consider the experience since the downturn in 2008. With unwavering perfection, the Fed has countered every downturn in the economy with massive amounts of stimulus. There was QE in 2008 and 2009, QE2 in 2010, and Operation Twist in 2011. And each time, after a brief improvement, the economy has dropped like a sack of potatoes.
It is no surprise that the economy’s weakening once again. Moreover, it’s no surprise the rumble for more stimulus is building. In a presidential election year no proposal to save the economy is too grandiose. Come Thursday we could find out what the Fed has in mind.
for Economic Prism