Smarter Investors: a Problem for the Fed

Against all odds, there’s a possibility investors are a little smarter than they were three or four years ago. That’s unlikely. Investors have rarely managed to climb up the learning curve. The recent stock market collapse is near-conclusive proof that they remain as gullible and reckless as their grandparents and great grandparents in the 1920s.

Yet the recent sharp rise in long term Treasury securities yields and drop in the dollar suggest that investors fear the Fed. Specifically, they may be concerned that the Fed is printing so much money (and the Treasury is borrowing so much money) that another asset bubble is in the making. Ten years ago, investors didn’t worry about bubbles because, by all indications, the Fed in those days didn’t worry about bubbles. The tech stock bubble, the real estate bubble, and the credit bubble have administered painful lessons. Investors now worry about bubbles.

It’s unclear that the Fed worries about bubbles. It’s printing money like there’s no tomorrow. If it continues to print money like this, there won’t be much of a tomorrow. Investors have learned not to trust governments, not even the U.S. government. They’ve tuned into the fact that governments tolerate and sometimes even facilitate bubbles. It takes gullible investors to create a bubble, but it takes governments to grease the process with easy money. Investors have seemingly made some progress up the learning curve. But the government remains a one-trick dog.

In the last year, the U.S. government has dumped shiploads of cash into the economy. This cash is supposed to spur economic activity. But a policy of printing money requires true believers. People, and investors in particular, have to believe in the value of the currency. Evidence of apostasy exists.

The Big Money Dump has had limited effect. Banks aren’t lending if they have any alternative whatsoever and investors are staying away from the asset-backed securities market, which in the past decade was the true banking sector. Consequently, much of the Fed’s money is going into asset markets—Treasury securities for a while, now petroleum, gold, silver and so on. The Treasury bubble is bursting fast. Petroleum is the trade du jour. But the oil price rise counteracts the basic purpose of all the Fed’s money printing. Rising energy prices are tantamount to a reduction of consumer income, the worst outcome for an economy that depends on consumer spending. Rising mortgage rates have the same effect.

Thus, the markets are undermining federal policies. Backwards looking economic data shows that the economy is no longer sinking as fast as it was six months ago. But sinking is still sinking. Going from panic to malaise won’t feel good for long. The key question is when will the economy turn around and begin growing. The answer depends on the forward looking data. With gas prices jumping sharply, mortgage rates following Treasury rates upwards, unemployment still growing, and worst of all investors getting smarter, the federal government’s prospects for forging an economic recovery remain fogged in, at best.