The Federal Reserve’s Flawed Bridge-Building Policies Leading To An ‘Unexpected’ Comeuppance

For over a decade, financial experts have criticized the Fed’s abnormal domination of the money markets. The 7-member Federal Open Market Committee has substituted itself as the sole determinant of short-term interest rates, thereby overriding capitalism’s key market-setting processes. 

The experts have pointed out the problems, especially the mismatched borrower benefits and the lender, investor and saver drawbacks. They have also laid out the heightened risks from misallocation of capital and resources. When the financial system recuperated from the Great Recession and the economy growth returned, the critics concluded that it was time for the Fed to cease and desist – in 2010.

However, the FOMC members, unfettered and left to their own devices, proclaimed that things were never quite “good enough” and the economy was still “fragile.” Therefore, they decided to stay the course, even expanding their operations to include huge purchases of longer-term bonds.

The Federal Reserve feeds the US Treasury’s deficit, thereby ballooning the money supply…

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However, as happens in Wall Street and the investment world, the dismay and dislike of Fed interference gave way to taking advantage of the situation. This approach was based on the a combined philosophy of “if you can’t beat them, join them” and “go where the money is.”

Still, expert analysis does appear periodically. The sizeable, multi-year damage to savers, investors seeking safety and income, insurance companies, pension funds and the like have been noted and measured. In spite of the facts, the FOMC has continued to repeat its “low rates benefit all” mantra.

The result? As with any oddball trend that overstays its welcome, the early critics have grown silent. This profound silence has increased during the Fed’s “fight” against the ill effects from the coronavirus pandemic. More fiat money supply, more debt, more misallocated capital and more misappropriated interest income from savers to borrowers.

A perfect example of misallocation’s damage that is still with us

The Wall Street Journal explained the problems in a May 2015 article, “Easy Access to Money Keeps U.S. Oil Pumping – Many investors find drilling attractive; lack of output discipline could keep prices low”

The two key items are “easy access to money” and “lack of output discipline.” Here is the abnormal picture that cheap money has created (underlining is mine):

Wall Street’s generous supply of funds to U.S. oil drillers helped create the American energy boom. Now that same access to easy money is keeping them going, despite oil prices that are languishing around $60 a barrel.

Helped by a ready supply of money, the flow of oil from the U.S. could keep crude prices low for the remainder of 2015 and beyond.

And this harmful combination of cheap credit and overproduction isn’t relegated to the U.S. and oil. Around the world, there have been gluts of commodities and resources. China’s slower growth often gets the blame, but that doesn’t explain why resource producers keep producing even as prices keep dropping. Cheap money does.

The bottom line: An unhappy ending awaits

Aided by the coronavirus pandemic, the financial system is headed into uncharted territory. Therefore, the best investing approach is to stay flexible and be prepared for taking abnormal steps as abnormal risks and opportunities show themselves. A good-sized allocation to cash reserves should be beneficial, both for pursuing opportunities and for keeping emotions in check.

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