The consequences of Fed intervention...

Oct 15, 2014

Cambridge, Maryland

Dear Diary,

The transport stocks managed a bounce yesterday. The Dow just couldn't get in the mood. It ended the day with a small decline.

Wolf Richter:

    But beneath the skin, it looks much worse than the benign 200-day moving average: 80% of the stocks in the Russell 3000 are 10% or more below their highs, according to Bloomberg. Many of them have gotten demolished. Some have gone bankrupt as the appetite for high-risk debt at these low yields is drying up.
Whether this is the beginning of a major correction or not, we don't know. We haven't gotten the email.

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But with the Fed cutting off its QE program this month, it seems likely that something will give. Zero interest rates and QE bailed out the financial sector, stabilized housing, and sent the US stock market up 130%. What will the end of QE do? We don't know, but we're eager to find out.

Japan and Europe are both putting out trillions in new cash and credit. In America, Janet Yellen hopes and prays that this will be enough to keep holding off trouble worldwide. Without substantial global liquidity the US stock market is likely to keep going down.

That, of course, is what we're hoping for: a big sell-off. Not that we want to see people lose money; what do you take us for? But we've been watching this show for many years now. We want to see how it turns out.

Just to bring you up to date, the US switched from gold to the kind of money that grows on trees back in 1968. That permitted a huge increase in credit...and debt. Thirty seven trillion in excess credit is what allowed Americans to live beyond their means for decades. They were spending money that nobody earned or saved.

Year after year, through democratic and republican administrations...through good times and bad...debt continued to build up. And as time went by, debt became more important. The US economy...and US assets...and US lifestyles...and the US government all came to depend on it. None could survive in its present form if it were forced to live on what it earned.

When the stock market panicked in 1987 Alan Greenspan came to the rescue with more cash and credit. It was a daring and provocative move; never before had the nation's chief banker expressed such an interest in stock prices. Previously, Mr. Market was responsible for the stock market and Mr. Central Banker stayed out of his way.

But ever since '87, central bankers have taken upon themselves the grave and absurd task of guarding speculators' backs. That's why the Fed intervened so heavily in 2001 and again in 2008.

The Fed may not be able to spot a bubble, but it has no such trouble when it comes to busts. And while it has no interest in pricking a bubble, it treats a bear market as though it were an ebola outbreak. Whenever there is the slightest hint of blood in the streets, it rushes in with hoses and disinfectant.

That's why we are so interested to see what happens next. Will the Fed come to its senses and let Mr. Market do his work? Will it allow investment mistakes to be corrected quickly and naturally? Or will it meddle once again...and make them worse?

Perhaps we will find out soon.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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