Forget Rates, Is The Fed Targeting Stock Prices?

I’ve written several pieces recently suggesting that the purpose of QE2 is widely misunderstood by both the investing public and a great number of those calling themselves financial professionals. Although many view the goal of Bernanke & Co’s latest program to be lower interest rates, my contention has been that the objective is to eliminate the possibility of a Japan-style deflationary cycle. But, upon further review, there may be more to it than that.

As the U.S. learned during the Great Depression and as Japan has learned over the past 20+ years, once a deflationary cycle gets started it is exceptionally difficult to stop. Thus, I’ve been of the mind that the Fed’s QE2 represents the FOMC simply erring on the side of caution at the present time.

However, based on some of the recent commentary from both current and former Fed officials, I’m beginning to see that Gentle Ben and his buddies at the FOMC may actually be targeting the stock market as a way to keep the economy on the up and up.

If you’ve read any of the accounts of the goings on during the dark days Credit Crisis, when just about every Wall Street bank was on the verge of collapse, it becomes clear that the biggest problems the government faced in terms of trying to put a finger in the dike were legal. They just didn’t have the legal authority to do what needed to be done. Thus, they needed to think outside the box and get creative. And in my humble opinion, this is exactly what Ben Bernanke is doing right now.

In light of the fact that the consumer is responsible for two-thirds of U.S. GDP, the fastest way to get the economy moving is to put John Q. Public and his family in a happy place. However, given that he’s underwater on his house, his 401(k) is now more like a 201(k), and he may be worried about his job (assuming he’s got one), it has been tough to improve the public mood.

So, since there isn’t much you can do about house prices and the government simply can’t force companies to hire more workers in this country, it appears that the Fed is targeting “asset prices” (i.e. the stock market) in order to make people feel better about their world.

The folks at The Chartist recently supported this idea by offering up four comments from Fed officials that I’d like to share. Take a gander at the quotes and see if you don’t sense a theme here…

Former Fed Governor Larry Meyers told CNBC on November 3, 2010:

From Ben Bernanke on November 4, 2010:

From Brian Sack of the New York Fed October 4, 2010:

From Alan Greenspan on CNBC December 3, 2010:

When I first read this grouping of quotes, my first reaction was, “Wow, this brings new meaning to the phrase ‘Don’t Fight the Fed!’” Although the FOMC clearly has no authority to target stock prices, it appears that Ben Bernanke’s gang does seem to have a decent grasp on the cause and effect game.

So, while the talking heads will likely to continue to argue the idea that QE2 is failing due to the fact that interest rates have moved up and not down, I’m going to suggest that one look at a chart of the S&P 500 tells an entirely different (and more successful) story. Higher stock prices do indeed make anyone with a 401(k) plan feel better. And I believe we saw this in the holiday-shopping data, which was consistently above expectations in the early going.

If you want to argue about something, I’m going to suggest that it might be best to focus on the massive amount of debt that has been created around the world and the question of how we’re going to pay it back. While I do recognize that we need to worry about an economic recovery first and debt second, it concerns me that members of Congress are never very anxious to talk about spending less money.

 

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