Always fight the Fed in the long-run
While in the short run the Fed can be all-powerful, in the long run I believe the only thing the Fed can do is create damage. The damaged is cause by the increased uncertainty and short-term distortions of the Fed’s unbridled hubris.
In the long run no single monetary force, even the Fed, can change fundamental economic behavior. Long-term economic success is driven by massive forces such as the fundamental institutions of the society, war, birth rates and so forth.
The Fed was not created to manage the economy. It decided to stimulate the economy and in so doing created a massive inflation problem. In crushing inflation it causes recessions. Now the Fed sees itself as the maintainer of economic stability. The Fed will hold back volatility like a dam holding back water until one day when the pressure gets to high and the dam fails.
Market volatility stems from underlying economic uncertainty, and economic uncertainty is here to stay. The Fed has dampened market volatility to the point that investors are becoming more and more complacent about financial risk.
I predict that the longer that the Fed stabilizes markets in the short run, the more devastating the volatility will be at some point in the future. I believe that the actions of a powerful Fed to stabilize an economy will turn out much like a wealthy person using drugs to stabilize their moods. In the short run, amphetamines will successfully counter depression and sleepiness. In the short run, barbiturates will successfully allow relaxation and sleep. But left unbridled, their long run usage is devastating as evidenced by the deaths of celebrities with the power to be unconstrained in their use of such drugs.
The Fed is out of control with its power and its confidence that it can control and manage the natural consequences of economic uncertainty and lead the economy higher and higher with blissfully low levels of volatility. The Fed will fail in the long run as it has with every previous endeavor. Volatility is a natural consequence of economic activity and it cannot be controlled in the long run. Investors should not try to time the market in anticipation of the Fed’s ultimate failure. But investors should select risk exposures and manage those risk exposures knowing that ultimately the Fed will fail bigtime in protecting us from a financial meltdown. While we should not fight the fed short-term with bets against its short run objectives, we should select strategic asset allocations with the sobering realization that even the Fed cannot create long-term economic utopia.
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