The Apolitical Fed and the “Big, Fat, Ugly Bubble”

The Apolitical Fed and the “Big, Fat, Ugly Bubble”

“ … nothing at the Fed is political.”                                                     Neil Kashkari, new head of the Minneapolis Fed

The Federal Reserve Board was designed to be a nonpartisan entity, existing solely for the benefit of the American economy. Apparently, there is a flaw in the design.

During the first debate between presidential candidates Hillary Clinton and Donald Trump, Mr. Trump accused the Federal Reserve Board of keeping interest rates near zero to help Democrats in November, while creating a “big, fat, ugly bubble” that will pop after the election when the central bank raises rates.

According to Ruchir Sharma, chief global strategist for Morgan Stanley, “This riff has some truth to it.”djia

“Since the Fed began aggressive monetary easing in 2008,” Sharma wrote on Zero Hedge, “my calculations show that nearly 60% of stock market gains have come on those days, once every six weeks, that the Federal Open Market Committee announces its policy decisions.

“Put another way, the S&P 500 index has gained 699 points since January 2008, and 422 of those points came on the 70 Fed announcement days. The average gain on announcement days was 0.49%, or roughly 50 times higher than the average gain of 0.01% on other days.”

It must be a coincidence that gains are 50 times higher on days when the FOMC announces policy decisions.

Sharma’s conclusions are further supported by this chart from Showrealhist.com, which shows an inflation-adjusted Dow Jones Industrial Average.  Note the upward surge that began when the Fed began QE in 2008.

Fed Increasing Income Inequality

The Fed’s actions did not influence the market prior to 2008, when the Fed launched its first round of quantitative easing (QE).

While the stock market’s performance has been less than stellar since 2014, when the Fed announced that it would “taper” QE, Sharma argues that the Fed’s actions are still boosting stock prices. With corporate earnings falling since 2014, stock prices should have been falling, too, but they haven’t been.

“Valuations—the ratio of price to earnings—continue to rise,” Sharma wrote. “With investors searching for yield in the low interest-rate world created by the Fed, the valuations of stocks that pay high dividends are particularly stretched. The markets are as dependent on the Fed as ever.”

A composite index for stocks, bonds and homes shows that their combined valuations are at the highest level they have been at in the past 50 years.

The net result is that the most-wealthy Americans have become wealthier, while working-class and middle-class Americans have suffered. With housing prices rising and incomes falling, the cost of a home is now out of reach for many Americans. Retired Americans who once counted on interest from their savings accounts to supplement their income have been seeing the value of their savings erode for eight years, even with the very low rate of inflation that has persisted through this period.

We’ve previously highlighted research titled, “Are Rising Stock Prices Related to Income Inequality?” which implicates the Fed in “an accidental admission that the Fed itself has been instrumental in creating the widest wealth and income gap ever seen in US history (now even greater than the Great Depression).”

Ironically, if the Fed’s actions are supposed to be helping the Democratic Party, they have a funny way of showing it, since the people who have been hurt most by Fed policy have traditionally supported Democrats.

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