A Valuable Lesson from the Fed

Don't fight the Fed...but don't get into bed with it either...

WE HAVE learned a valuable lesson, writes Daily Reckoning Australia editor Dan Denning.

Just because you're not fighting the Fed doesn't mean you should be in bed with it, or trust it, or otherwise put your financial fate in the hands of fickle, feckless, and duplicitous central bankers.

Hare markets opened with a sea of red numbers after yesterday's action in New York. US stocks fell the most they've fallen since November of last year. And they were getting so close to making new all-time highs. What caused the stampede of selling? It was the Fed.

Specifically, the minutes from the Fed's January meeting. If you have a vivid imagination, they make for good reading. You can just imagine a bunch of well-heeled bankers, under the illusion they are pulling all the right levers and turning all the right dials, arguing with each over biscuits and coffee. There is dissension in the ranks over further asset purchases. Let's go to the notes, with our own emphasis added, to show the confusion and dissent:

'Many participants also expressed some concerns about potential costs and risks arising from further asset purchases. Several participants discussed the possible complications that additional purchases could cause for the eventual withdrawal of policy accommodation, a few mentioned the prospect of inflationary risks, and some noted that further asset purchases could foster market behavior that could undermine financial stability[...]

'Several participants emphasized that the Committee should be prepared to vary the pace of asset purchases, either in response to changes in the economic outlook or as its evaluation of the efficacy and costs of such purchases evolved[...] A number of participants stated that an ongoing evaluation of the efficacy, costs, and risks of asset purchases might well lead the Committee to taper or end its purchases before it judged that a substantial improvement in the outlook for the labor market had occurred. Several others argued that the potential costs of reducing or ending asset purchases too soon were also significant, or that asset purchases should continue until a substantial improvement in the labor market outlook had occurred[...]'

To credit junkies who base their stock market decisions on front-running the Fed, this kind of talk is enough to make your knees knock. Is the Fed seriously considering winding back its asset purchases? Is it losing its nerve? Is it less committed to the idea that pumping up stock prices reduces unemployment?

Well, if you were being cynical (realistic), the thought might occur to you that low interest rates have always been about pumping up stock prices and lowering the cost of government deficits. The whole business about lowering unemployment through cheaper credit is just a line to feed to the proletarian mugs. Let them eat low rates!

Maybe the Fed is worried about creating another asset bubble. But here's a newsflash, it's too late! The volatility index (VIX) spiked yesterday as surprised investors realized they're playing the Fed's pump and dump game. It's Bernanke's world for now, and we're all just along for the ride.

Time to Buy Gold?...