The Fed’s Focus on the “Wealth Effect” Is Idiotic

Baby Ben Bernanke

Fed Policy Has Benefited a Small Handful … But Not the Economy As a Whole

We’ve repeatedly noted that the Fed’s main strategy has been to artificially blow bubbles in asset prices.

And we’ve repeatedly pointed out that one of the Fed’s main goals is to boost the stock market, yet the great majority of Americans – the bottom 90% – own less than 20% of all stocks and mutual funds. So the Fed’s effort overwhelmingly benefits the wealthiest Americans, and doesn’t help the general economy.

Barry Ritholtz has a great post at Bloomberg about the Fed’s idiocy of the Fed’s focus on the “wealth effect”:

When will these guys ever learn that maybe, just maybe, these Fed policies aimed at targeting asset prices at levels above their intrinsic values is probably not in the best interests of the nation?

-Dave Rosenberg, chief economist and strategist at Gluskin, Sheff

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[What bugged me most about Fed policy] is the Federal Open Market Committee’s focus on the so-called wealth effect, and its corollary impact, the stock market’s reaction to Fed policy.

Let’s begin with a quick definition: The wealth effect is an economic theory that posits rising asset prices leads to beneficial effects in consumer sentiment, retail spending, along with corporate capital expenditure and hiring. It is based on a belief in a virtuous cycle that begins with equity prices. As they rise, investors and senior corporate managers begin to feel more secure and comfortable in their financial circumstances. This improvement in psychology releases the “animal spirits,” along with a commensurate increase in spending. Pretty soon thereafter, the entire economy is moving on the right direction.

But Fed policy makers seem to have gotten this precisely backward. Their premise is based upon a flawed statistical error, one that confuses correlation with causation. Building an entire thesis upon a flaw is likely to lead to poor results.

Why is the wealth effect a flawed theory?

Start with that correlation error: What actually occurs during periods where stock prices are rising? As Benjamin Graham observed, over the long term, markets act like a weighing machine — valuing equities based on their cash flow and earnings. During periods of economic expansions, it is the rising fundamental economic activity that reflects the positive things wrongly attributed to the wealth effect. Companies can hire more and increase their capital spending. Competition for labor leads to rising wages. Employed, well-paid workers spend those wages on capital goods such as cars and houses, and discretionary items like entertainment and travel.

Oh, and along with all of these economic positives, the stock market is buoyed as well, by increasing profits and more buoyant psychology.

In other words, all of the same forces that drive a healthy economy, leading to happy consumers spending their plump paychecks, also drive equity markets higher. The Fed, though, seems to think that the stock-market tail is wagging the fundamental economic dog.

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The flaw in this thesis is even more obvious when we consider the distribution of equity ownership in the U.S. The vast majority of employees and consumers have only modest investments in equities.

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With so few people actually invested in the results of the stock market, how can it have such a broad effect on consumer spending?

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Which leads to a Fed policy that has become overly concerned with the markets reaction to well, everything. Fed policy, FOMC member speeches, even FOMC minutes are obsessively considered in light of how markets will react to them. This is a terrible and unique Fed error.

No wonder only higher income brackets like Fed policy.

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  • berger friedrich-wolfgang

    Given the fact , that the “FED” – is part of the “Private , Zionistic , Global – operating BANKSTER – Syndicate” , – the “Keeper & Guardian” of the “Jewish TEMPLE – TREASURE” (in “Association with WALL – STREET”) , – the “Care for the(ir) WEALTH” , is in “No – Way – Idiotic” ! — The “deceitful – propagandized ILLUSION” , that “All the privately – organized ISRAEL – FIRSTERS” , who run most of the “US – Governmental INSTITUTIONS” , care for the “”99 % – Non – Jewish AMERICANS” , “already has been demasked as – SCIENCE – FICTION” !!!

  • Tonto

    The stock market is also a social device. And like all credit systems, the stock market creates money. This is similar to counterfeiting currency, just like the credit systems in our society, which also act in a manner that essentially counterfeit money.

    When one invests in the stock market, their money goes to purchase stocks and pay broker fees. If the price of the stock rises, then out of thin air, the stock owner is the beneficiary of the counterfeiting that is accomplished by the stock market. Though someone may be paying more for the same issuance of stock, the rise in value in all stock shares issued, creates a monetary value store, that did not exist before the rise. This creating of a monetary value store is very little different from counterfeiting the currency.

    Of course, the counterfeited money can evaporate when the price of stocks falls. But the Bernanke FED did not let the stock market fall. So the Bernanke FED was backstopping what is really nothing more than a counterfeiting operation.

    This is the moral hazard of the Bernanke FED.

    The erudite economic argument that justifies this questionable Bernanke FED behavior, is that things would have been much worse, if the Bernanke FED did not backstop the stock markets. It is the implicit notion that some insiders were privy to the intention of the Bernanke FED backstop to the stock market, that is so suspect. Trillions of dollars in a counterfeit monetary stores of wealth were created as stocks rose since the collapse. And those who knew what the FED was doing, and the FED’s implicit intentions in so doing, (despite being repeated denied by the Bernanke FED), traded stocks with extreme confidence. They could not lose, because the Bernanke FED was plowing all its support into creating this stock market based counterfeit store of monetary wealth.

    As with everything in our economy, we are watching an economic war take place. The winners have been almost exclusively the American banking class. This bodes well in the international scheme of things for the continuation of the American financial empire. The end result of the Bernanke FED may even prevent World War III.

    Either way, the American banking class has no intention of taking a back seat to anyone in the world, regardless the moral hazards encountered by the Bernanke FED, or the moral hazards of world war.

    • Tonto

      If you want to read about morality, and the use of morality to justify all manner of things, then the following book is a good place to start in our modern world. I am a strong believer that our increasingly enhanced understanding of morality is the only sign of human progress. In fact, it is only on the moral front that anything is accomplished. Enhancing the moral understanding of humanity is the only thing that makes a whole life truly enjoyable. Enhancing the moral understanding of humanity is also the only thing that will sustain life for the future of humanity.

      http://www.amazon.com/dp/B00HI1BXEQ

  • Name

    It’s one of the oldest stories in the world. The hucksters’ clandestine companion sold TPTB a pair of magic glasses with which they could see through the shells to spot the pea. After a number of successful test runs, TPTB decided to bet everything: the wealth of businesses, governments, and individuals. This time, they were going to show the hucksters whats what.

    Except, of course, that one time the glasses failed and they lost it all. So they are faced with a choice: tell the hucksters to stuff it, or tell their populations to eat it. For TPTB, the problem with the former choice is that they’d have to admit how unimaginably stupid they were and most likely they’d lose all credibility. So, bon appetit, my friends!

  • gozounlimited

  • http://khanneasunztu.wordpress.com/ KhanneaSuntzu

    Dumb Americans are unable to get beyond blind belief to see the hostile take-over of their dreams.

  • Joe

    These silver spoon policy makers, what do they know. They work in a sector that have very little direct contact to the society.

  • gozounlimited

    REAL “WEALTH EFFECT”…..

    A very moist “Pineapple Express” flow of air from the Hawaiian Islands will impact California through
    Sunday, likely bringing enough precipitation to make a noticeable dent in the state’s dire drought conditions. Some locations may see more rain in a four-day period than they have had during the previous eight months. NOAA’s Weather Prediction Center is calling for most of Northern California to receive more than 2” of precipitation through Sunday, with many higher elevation areas expected
    to get 4 – 6”. Up to three feet of snow is predicted to fall in the Sierra Mountains.

    This weekend’s Pineapple Express is a marvelous break from the extraordinary dry conditions that have gripped California for the past thirteen months. If one could put a monetary value on the moisture from this storm, I speculate that it would easily be worth a billion dollars…… That We Will All Share Equally Instead of a Few Evil Men…… http://www.wunderground.com/blog/JeffMasters/comment.html?entrynum=2627

 

 

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