By now everyone should know that nothing good happens, when the FED prints money. If not, then this post today will give you a good idea. You may be able to put it to use in you personal investing.
When we hear that the FED is printing money we need to now that they are not literally printing dollars bills in the basement. But they are doing something equally destructive.
Instead of creating dollar bills, the FED credits the accounts of the various money center banks with fiat money. This has the effect of increasing the available money supply.
But this crediting function of the FED does something equally destructive: It artificially lowers the rate of interest that is paid on bonds below the rate that individual consumers would demand in the unhampered market.
Remember: Time preference is the real principle that should be telling the market how the economy needs to function. Not an artificial rate setting gamester at the FED.
Another thing to remember is the Inverse relationship between rates and bond prices: And the normal negative correlation between stocks and bonds.
When rates come down, the price of bonds go up and when rates go up the stock market normally goes down.
This makes sense!! When the cost to borrow money is more expensive, businesses look more deeply into the value of their future investments.
If it costs more to borrow money, a business needs to know that the consumer is willing to by a higher price in the future for the goods that will be brought to market.
The entrepreneurial function of a business owner is to take a risk about the future
When consumers time preference is low (meaning the consumer is willing to postpone present consumption for future consumption), the additional savings has the effect of lowering interest rates to the normal rate (the rate consumers are willing to accept to postpone consumption in the present.)
The marketplace is very good at signaling its desires for more or less consumption.
However, when the FED steps in and credits banks and the US Treasury with additional resources, rates are effected in a way similar to a consumer postponing consumption.
But there s a BIG difference.
When the FED increases the money supply, the producers get a FALSE signal. They are led to believe that the consumer is willing to postpone current consumption.
In fact, when the FED “prince’ money, it sends the opposite signal to the market.
Another important thing to remember is the effect a low interest rate has on the consumer.
It is one thing to be willing to save, and put money away for a rainy day, but, when rate are “artificially” low, who in their right mind wants to save for 30 years and get (currently 1.93%) Maybe someone’s grand mother, who doesn’t care. But even she knows the risks she takes by doing that. If you doubt me, give her a phone call
Consider the Inverse relationship between rates and bond prices:
When rates come down, the price of bonds go up. And when rates go up, the stock market generally weakens. But not 2020.
The whole negative correlation of bonds and stocks has fallen out of bed.
You are probably getting the picture.
Our economy is a sham. We are hanging on by our fingertips. Rates are artificially low. Individuals are NOT saving money as rates simply. Businesses are producing future goods that the market is NOT demanding. The prices of many companies are highly inflated due to excess reserves chasing their stock prices.
I fear the center can not hold.
In fact 2020 was a year that has pointed to the major dislocation of the market from reality.
Unemployment is at record highs and yet the stock market is at record highs and until very recently, bond prices have been at record highs.
This is very wrong.
People ask me all the time about what to do. If rates are giving false signals to the stock market investor, and it doesn’t pay to save money in a bank or even a CD for that matter. What do you do?
In my next post I will be talking about “true diversification”. Not some phony 60/40 BS allocation recommended by a money gatherer for a large institution.
Stay tuned. It’s about to get interesting.
