Capital Markets Will Correct Federal Reserve Irregularities

Time’s up. The fallacy-driven beliefs and actions have had their turn. Once again, the visible irregularities are stretched. Therefore, the misshaped environment is ready to produce profits from reality-driven investing.

So, what are the irregularities?

First off, know that the Federal Reserve is neither a perpetual source of wisdom nor an accurate forecaster. Instead, it periodically makes costly mistakes.

The 19-year period of Ben Bernanke, Janet Yellen, Jerome Powell has been especially harmful. Its interest rate actions significantly disrupted capitalism’s key strength: the capital markets’ pricing process (interest rate determination) between capital providers and users.

Especially harmed have been the $trillions held by savers, conservative investors, funds, companies, non-profit organizations, and state/local governments that wanted a safe haven with a non-risk, real income flow. Note the “real” proviso. That means a payment that at least compensates for inflation (AKA the loss of the dollar’s purchasing power). That is a key demand by capital providers, so it a key measure of capital market effectiveness. However, the Federal Reserve overrode that need by forcing the safe interest rate level down to 0% for years, eroding savings, forcing the spending of capital, and overturning the likes of insurance companies and pension funds that depended on a real return to meet future payments.

The depth of lost purchasing power created by the Fed…

So, why did the Federal Reserve force the 0% rates? Because it believed that the money would go to capital improvements, economic growth, and increased employment. However, the cheap borrowing simply allowed the U.S. government, large companies, hedge funds, private equity funds, and wealthy individuals to improve their well-being. Then when his promised improvements didn’t happen, Ben Bernanke didn’t stop his experiment but said the 0% rates needed to be extended. He also added some inflation-producing increased money supply (which he called quantitative easing).

After Bernanke’s eight years, Janet Yellen served four years, only increasing the interest rate a smidge. Then came Jerome Powell, who made multiple missteps. Especially damaging were his extended 0% interest rate and significant money supply expansion during the Covid period even as inflation began to jump.

And that is not the only damage done. The years of the Fed explaining itself in a positive light has produced a misleading education for investors. While a corrected capital market can help reeducate, it will likely be a long and not necessarily successful process.

The bottom line: Things are changing

First, there is more being written about the Fed’s mistakes now. That is a good educational step, plus it puts the Fed on notice that they no longer have full rein to take any action they choose.

Second, the capital markets are acting more independently again, with longer-term rates rising to more normal positions. Thus, Wall Street is necessarily judging risk and return with less consideration of what the Federal Reserve might do.

Third, there remains numerous pockets optimism that are overriding fundamentals. Bringing back capital market-based analysis will reduce the excessive pricing.

Fourth, there also are many companies just hanging on. Some speculators have enjoyed playing with them, but such games are always temporary.