The Fed's Secret Plan

The Fed's Secret Plan
by Mark Young

(originally published in the Guru Review)

It is no secret that the Fed is essentially printing money. Liquidity is being created by the tens of billions daily. This has more than a few folks more than a little bit worried about inflation. It is axiomatic that the Fed governors are also greatly concerned. Yet they continue to pump. Why?

The answer is that they are more worried about economic collapse than they are about inflation. Fine. The thing is, inflation will be a problem sooner or later as a function of this massive and on-going liquidity injection.

So, what is "The Plan"? What is the Fed up to?

Any casual observer knows that the stock market has been grinding higher for months with the most recent decline the first since November. More and more Bullishness is being generated and more and more trust in the market's trend is being manufactured. The Fed has actually said that they want higher stock prices.

Of course they do...

Since the melt-down of '08-'09 most of the big Wall St. players have been in the hip pocket of the Government, which means that the Fed has no mere modest influence over some very big players. These players are more than able to create and maintain a trend.

Here is my speculation: I believe that the Fed knows that excess liquidity will not go into speculative real estate nor will it go into bonds, as rates are too low, plus there is a healthy respect for credit risk these days. This leaves essentially two places (at the moment) for that cash to go; Commodity speculation and the Stock Market. The Fed does not want the former (inflationary) but they DO want the latter. I suspect that the Fed is using every tool at their disposal to lure as much money as possible into the stock market.

I am speculating that the Fed is trying to create a sense of security that sucks excess liquidity from "risky commodities" to "low risk" stocks. This will help to keep inflation from exploding out of control. So far, it would appear that this is meeting with some success. It probably needs to meet with more until the economy firms and unemployment wanes.

It is important to remember that if inflation really accelerates, the Dollar will collapse and foreign investors will flee US bonds, driving rates higher. This would be DISASTROUS for the nascent recovery. Additionally, the Fed doesn't want to raise rates much themselves (on the short end) because they also don't want to be responsible for killing what little recovery there is. The thing is, they won't need to if they keep excess cash going into stocks. Further, the ever rising stock market creates foreign demand, which will tend to support the dollar as well and keeps the bond market reasonably firm.

So, assuming my speculation is correct, how long does this "stock market support" continue? My guess is that until un-employment falls to 7% or 8% give or take. The economy has to have improved enough so that there is demand for money to buy/build physical capital. When rates start to rise based upon this demand, the Fed will remove some support from the market. If prices continue to hold up, or rise, they will advise their "partners" to liquidate. Falling stock prices will likely drop rates as money flows from stocks to bonds again, lowering borrowing costs and keeping the economy humming. Prices will fluctuate more normally at that juncture.

At some point in time, the economy is going to be very healthy looking, and growth may be almost too hot and an inflation threat. This will bring the surprise. The Fed will then orchestrate a more serious decline. How will this help? Prices are set at the margin and there are times when stocks can decline precipitously on relatively little volume. I'm thinking that the Fed plans to nip inflation in the bud by sending hundreds of billions of liquidity $'s to "money heaven" by engineering a precipitous decline. If it's fast enough, it won't fee much money at all from stocks (which could then go into more inflationary assets), but rather trap that excess liquidity in stocks for the foreseeable future. This may be cynical, but I think it very likely that an academic with that much power will try to outsmart the market. It may work, too, despite the ethically questionable aspects of the plan.

Again, this is merely a speculative hypothesis, but it resonates with me. My read is that if I'm right, we're going to want to be thinking long as much as possible until the economy heats up and unemployment drops.

We published this on Traders-Talk as well, and the discussion that this generated was both insightful and voluminous. There was a lot of good analysis and further fleshing out of the concepts. I commend the discussion to your attention.

http://www.traders-talk.com/mb2/index.php?showtopic=127058

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