The Fed Flinches, Market Participants Get Burned

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As you know, I am a completely dedicated voice of the former middle class. I know their pain, I understand their frustration, and I appreciate their challenge in a time when the job market sucks. Most of all, I get it when it comes to loss of faith in a government that is controlled by the wealthiest 1%.

But gaul dang it, even rich folks have bad days sometimes too, you know. So don’t think just because you rely on food stamps, drive a 17-year-old Pontiac and shop at The Salvation Army that you are the only one with problems. Instead of crying in your beer, go down to your closest Best Buys and watch CNBC for a while, and you will get some needed perspective.

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Ben Bernanke

What I am talking about is the distinguished chairman of the United States Federal Reserve System, Mr. Ben Bernanke. He has been shifting positions lately and that has shaken up both the bond markets and the stock market as well. And that means that all those poor little rich people have had a couple of hundred billion taken out of their hide. So remember when you compare your measly few dollars in food stamps to their hundreds of billions of bucks, you will start to appreciate the plight of others!

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What we are talking about here is a shift in Mr. Bernanke’s assessment of the economic condition of the United States of America over the past few months going from optimistic to cautious. You and I can change our minds without impacting very much, but not Mr. Ben. Those who are economic wonks know that the Federal Reserve’s policy of Quantitative Easing (a.k.a. QE) has had a goal of driving interest rates to near zero levels while injecting massive liquidity into the system through the monthly purchase of about $85 billion in long-term government debt.

The moribund housing market has a new sense of confidence. Prices have risen. Supplies are short. People are starting to admit once again that they are Real Estate brokers. My inbox runeth over from brokers I haven’t heard from in years. Hell, a few people with FICO scores in the 600s are even getting mortgages. The fact that the job market remains a mess doesn’t seem to spoil the optimism of the National Board of Realtors.

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Here is the simple truth. The US economy remains fragile due to structural imbalances that have been underway for decades. The long-term shift from a manufacturing-based economy to service-dependent is a big fat negative for jobs. The jobs that have been created since the “Great Recession” began about 2008 have been hourly work mostly paying under $12 per hour. (At the peak around 2005 the hourly cost of a union assembly line worker at General Motors was over $75). For each four jobs eliminated either by technology or the Great Recession, little more than one is being created in the glorious service economy of 2013.

However, the simple truth is not really that simple. As fragile as things are here, elsewhere in the world it is even more delicate. The countries, mostly Western European, that make up the Euro Zone are still teetering on the edge of insolvency. Countries like Greece, Turkey, Italy and Spain that have been bailed out once already are likely going to be back at the monetary feeding trough before long.

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Why Is Greece So Important?

So what does the rest of the damn world mean to you and me? The Federal Reserve is in a conundrum right now. If it continues its policy of Quantitative Easing with near zero interest rates for an indefinite period, it undermines price stability. This is the opposite of what the FOMC (Federal Open Market Committee) is all about. What we are talking about is the prospect of much higher inflation than any time in the past 15-20 years. If things look a bit on the dim side to you right now, imagine your cost of living going up 8%-12% each year as it did in the early 1980s. Not good you say? Quite right you are.

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ed-ar061_mackin_g_20130729141853On the other hand, the United States dollar is the benchmark currency in the world today. Thus how the Fed sets monetary policy, including interest rates, echoes across the globe. If the Fed were to cut back on QE by reducing bond purchases and interest rates continue to rise, the ripple effect would likely drag the Euro Zone back into the same economic crisis it faced in 2012.

The winds of change are blowing over the Federal Reserve with Mr. Bernanke’s term coming to an end later this year. Yet whoever becomes the new chairman will inherit the same problem. In our previous ramblings we have pointed to the need for relief in the form of fiscal policy actions. Once you get to zero on the interest rate scale, there is little more the Fed can do. But only someone who has inhabited a lonely spot on the dark side of the moon for the last few dozen years would be so naive as to expect Congress or the White House to come to the rescue.

Back in my earliest days as a Wall Street analyst, I learned the mantra: Don’t fight the Fed. When money is being made cheap and easy to obtain, that is the time for optimism. This is where we have been for the past five years. The end of the golden age for cheap money is nigh. With bond and equity prices likely to go no higher when money costs inevitably rise, there may be more days when it is a bitch to be rich!

So What’s So Good About Being Average?

The government has come out with some cheery statistics in recent days. After breezing through a few, I experienced genuine gratitude that I don’t live in North Korea. How much better we have it here! Hooray for us. If you think I am being stupid and sarcastic you may be right about the first. But just wait until you get a load of this new data.

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A shrinking U.S. middle class.

The Census Bureau reported that median household income, adjusted for inflation, was $51,017 in 2012, down about 9 percent from an inflation-adjusted peak of $56,080 in 1999, mostly as a result of the longest and most damaging recession since the Depression. Most people have had no gains since the economy hit bottom in 2009. But that was just the beginning. This report underscores that the economic recovery has largely failed to reach the poor and the middle class, even as the unemployment rate continues to sink and growth has returned. For all of us out here in the real world, this news must have come as a complete shock! Right? Here we were going along our merry way thinking this life we were living was nirvana. Wow, thanks Census Bureau for the helpful guidance.

But wait, there is more ebullience to savor. We Americans may be in a tough period right now, but surely we are better off than those poor bastards in other countries. Right? Not so right. It turns out we could be the poor bastards in our own country. On September 17, the Census Bureau announced that the poverty level remained stuck at 15 percent in 2012, the same as the year before and some 2.5 percentage points higher than in 2007 – before the housing bubble burst and sent the United States careening into recession.

What the report doesn’t explain is that poverty in 2012 is calculated based, among other items, on how much families spent on food in the 1960s. Ridiculous as it is to overlook the fact that eating habits and the cost of food has been one of the most changed items in our lives, as well as the most inflation-sensitive components to our cost of living.

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The Organization for Economic Cooperation & Development (OECD) calculates the poverty equation more in keeping with the European approach. This arrays poverty across all countries large and small, industrialized to third world. What they found is that the poverty level in our dearly beloved country is the highest in the industrialized world. Only Chile, Turkey, Mexico and Israel rank higher on the poverty chart.

While some days it is a bitch to be rich, for 15% of our fellow citizens, including the 40 plus million Americans on food stamps, the bitch is every day.