Federal Reserve Overstepped Bounds With Monetary Policy

Checks & Balances

If you think about it the President has checks and balances, the Supreme Court has checks and balances, and even the two houses of Congress have checks and balances. 

However as we have seen with the last 5 years of Fed policy that there is no actual checks and balances for what the Federal Reserve can and cannot do with regard to monetary policy, and there should be. 

It might not be so apparent now, but it sure will be five years from now when all is evaluated. The big takeaway will be how in the heck did we let the Federal Reserve conduct all of these ad-hoc policy initiatives with some obvious detrimental effects and unintended consequences for financial markets and the US economy? 

 

Where would Markets Go without $75 Billion assistance each month?

 

Let us start with the most obvious detriment to financial markets the bubble that is the US equities market. Despite what Goldman Sachs says  with their double speak to appease wealthy clients who they told to be invested in markets last week and this week said the markets are 10% over-valued, but there is no bubble – there is in fact a bubble in stocks.

 

Seems like a Bubble

The barometer to use is this: If the Fed stopped cold turkey tomorrow all asset purchases, the Dow would drop 3,500-4,000 points in less than a year (maybe even as little as 6 months), and this is a conservative 25% drop in value just in the short term. 

If they were never allowed to intervene in financial markets with asset purchases ever again, eventually markets would fall back to sustainable levels, and all the previous liquidity fueled price appreciation in equities of the last 5 plus years would eventually come out of assets like stocks and real fundamental value would be established. 

 

My guess is that the Dow would fall back to around the 1,000 level on its own merits over the next 3 years with no asset purchases whatsoever by the Federal Reserve, something in the order of a 40% drop in value.

Bond Market: A Debt Risk Valuation Mechanism 

The Bond market is intended for debt to be issued by parties with parties independent of the debt issuers to then determine a fair market price for the risk of holding said debt in the marketplace, and not a social instrument for creating additional liquidity in financial markets which finds its way into the equities, commodities and currency markets via carry trade liquidity driven fund flows.

 

It is supposed to be a risk profiler to keep governments and issuers in check in regard to issuing responsible debt at appropriate times. When debt levels reach unsustainable levels, a healthy and natural bond market prices risk accordingly; thereby incentivizing necessary changes to fiscal and monetary policies.