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The More Things Change, The More They Stay The Same
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The More Things Change, The More They Stay The Same

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The More Things Change, The More They Stay The Same

While walking to the post office last summer, I stopped into a vintage mid-century furniture store named Revival. I wandered into the store that day because I recognized the furniture from my childhood. They say, you can't go back, but for the moment, I proved the cynics wrong as I stepped into this kitschy store, and stepped back in time. My elation was short-lived however, as I realized the century being referred to was the twentieth, and that mid-century was in reference to the 1950's, the decade in which I was born. Newly classified a mid-century antique, I immediately wondered if I should be calling a cab, instead of making the round trip home on my vintage legs. I chose to gut-it-out though, and walk home, affording myself the time to contemplate a much simpler era.

It was a time when we kept our money in savings accounts, and kept tabs of our funds in passbooks. Americans drove American automobiles, women stayed home and raised the kids, and "Father Knew Best". Ozzie and Harriet, Andy Griffith, and Dick Van Dyke were not only the most popular shows on television, but icons of pop culture and symbols of the American dream. Kids played sports, (not video games) - people typed on typewriters, and everybody read the newspaper. However, the fifties' ideals were contradicted by a clear social and political dichotomy. Racial discrimination pervaded daily life, there was little concern for the environment, and the government adhered to a lunatic doctrinal framework which was the basis for a Cold War, that would soon bring our country to the brink of nuclear disaster.

While the Fed''s monetary policies of the 1950's are often criticized, the decade's economic performance contradicts the critics claims. Inflation, measured using the GDP deflator, averaged under 2.0 percent per year between 1952 and 1960, and it never went above 3.3 percent in a single year. Real GDP over the same period grew at an average rate of 2.9 percent per year, and the unemployment rate averaged 4.7 percent. While there were two recessions during this decade, the one in 1954 was exceedingly mild, and the one in 1958 was sharp but very brief. The Fed of the 1950's was obviously just as concerned, as today's Fed, when it came to controlling inflation, and the economic results of their actions, suggests they had figured out the essence of sensible policy. However, economic, social, and demographic factors were different in the 50's; people were big savers, frugal spenders, and were cautious about purchasing items on credit, even though credit was easily available. Oil was still cheap and abundant, and was produced domestically, not imported. Interest rates were relatively low, there was a trade surplus, and the dollar reigned supreme. It was the beginning of the baby boom, and it was the time when women began to enter the workforce.

There have been some encouraging trends since the 1950's; a heightened concern for civil and human rights, including the rights of minorities and women, and a growing concern for the welfare of the environment. Technological innovation dramatically increased our access to information and enhanced our lives, but concurrently created a digital divide. Our economy experienced tremendous growth and was integrated into the global economy, but progress inadvertently introduced problems that affected economic stability and quality of life. With the gross national debt now over 13 trillion dollars, a myopic federal government continues to implement short term solutions at the expense of future growth. Ironically, the same policy makers that originally created these problems, have often lacked either the political will or expertise to correct their mistakes. The Fed's treatment for our economic ills, has always been to lower interest rates and boost liquidity, a cure that may be far worse than the disease itself.

As a result, of these policies the American consumer's wealth has been destroyed because of the record drop in home prices and decimated retirement plans. Unemployment is still near 10%, and home foreclosures and bankruptcies are setting records, as over-leveraged consumers are increasingly squeezed by unaffordable home-equity loan payments, and rising food and energy costs. Even for those who qualify, credit is unavailable, and a declining dollar is reducing the consumer's buying power and causing a shift to other currencies for foreign trade.

2 years ago, fiscal stimulus from the bailout, artificially low interest rates, and the added liquidity provided by QE1 both enabled and forced capital to flow toward riskier assets. With risk mitigated by an acknowledged Fed put and a low yield environment that offered minimal returns on safer assets, the market responded with a 550 point rally in the SPX off the March lows.

But, shell shocked from the recent collapse of the equities market, the flash crash, and the dominance of high frequency trading, investors had deserted the equities markets for the perceived safety of fixed income, gold, and commodities. The retail trade is out of the market, as are the hedge funds, mutual funds; and the pension funds are next to go. All that is left are the indexers and automated traders, and the concentration of stocks they are trading is getting smaller and smaller. In essence, what's left of the equities markets, is solely a vehicle for technical traders and robots. It has ceased to function as reliable mechanism for price discovery and is decreasing in importance and functionality as tool for capital formation.

This has left the door open for the Fed, with help from the 18 Primary Dealers, to artificially ramp up stock prices. There is so much interference by the Government and the Fed that the markets have become distorted. The result is that people are afraid to allocate money to the markets because they can't get good information from the markets. And the more the government and the Fed meddles, the more money will flow out of the market and flow into less risky assets, or just sit on the sidelines.

In an effort to scale back the vast amounts of money it pumped into the economy, the Fed had begun to drain reserves by conducting reverse repos, proposed a plan for term deposits, and terminated it's security purchase program at the end of last March. However, they soon realized that while the market had rallied substantially, there was a tremendous disconnect with the real economy. The real drivers of sustainable growth; employment, corporate investment, housing, and consumer spending, were all lagging far behind.

Fed intervention through permanent open market operations was the immediate response to this situation, however it seems inevitable that further action in the form of an anticipated QE 2 is imminent. In my opinion, QE2 is going to be the mother of all fades, i.e., buy-the-rumor-sell-the-fact. The rally in equities in September was due to almost $10 billion dollars a week of Fed intervention, and institutional "front-running of the fed" in anticipation of a QE2 announcement on 11/03/2010. The more the market rallies ahead of the announcement, the more the easing is going to be priced into the market, and the harder the crash in equities that follows upon actual implementation.

In the past, such low interest rate/loose monetary conditions/central bank intervention, has resulted in bubbles due to the speculative excesses in riskier assets. Paradoxically,this rally is different due to the lack of investor participation and the predominance of government manipulation, but paradigmatically, the market may be setting up for potential price exhaustion, and the bursting of this de facto equities bubble. One caveat however - even though this rally may be significantly overvalued and overextended, it could extend even further as traders continue to price QE 2 into the market.

The Fed's over-reactive policies date back to the borrow-and-spend Regan years, through the doubling-of-our-debt Bush years, to what will undoubtedly be the redoubling-of-our-debt Obama years. It strikes me as ironic then, that the furniture store I walked into that day, was named "Revival": a new presentation of an existing theme. The Fed once again expects the American consumer to re-inflate the economy, but the consumer is already over-borrowed, over-spent, and broke. Besides, the banks aren't lending money; instead they continue to hoard cash and play the carry trade, borrowing money for next to nothing and investing it in government bonds.

So while the past abuses to the financial system, (culminating in the bursting of the sub-prime bubble), has structurally changed the global economic system, dealing with these problems have remained the same. We all understand, you can't go back, but we should also realize...the more things change, the more they stay the same.

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