Fade the Fed on Housing

A common aphorism for traders is "never fade the Fed." Great import used to be placed in the money supply, and the Fed's FOMC statements were scrutinized for nuance to give a hint as to future direction. As inflation faded, so did that scrutiny. Today great import is placed on the Fed Funds rate, and FOMC statements are analyzed for any change of language. Nothing much changed today, and the market went up. 

I sometimes wonder if our society has gone Medieval, arguing over how many angels could fit on the head of a pin; or today, how many angles can fit within the spin of the Fed. 

The Fed initially was formed to handle bank panics, specifically the Panic of 1907. It had a regional structure, much like what existed before the Fed was formally made the central bank in 1913, and the regional banks issued notes with varying rates depending on the health of that part of the country. They stood ready to back a failing bank and prevent a run, and then failed their first major test in 1931. 

The Fed was expanded in the 1930s to manage Treasury issuances, and hence the money supply; and in the 1970s was expanded again to be required to push for a full-employment economy. This made no sense, as controlling money and pushing employment can be contradictory goals, as we all found out: the pressure to inflate to keep the economy going led to a debacle that tight money had to settle. 

Today the Fed has been expanded again, and is now seen as the overseer of the whole economy. This adds even more contradictory goals to the Fed's role. When an institution is pulled in conflicting ways, how can the "never fade the Fed" aphorism make sense? 

To me this was clearly spelled out in recent FOMC statements about the economy. Today's statement was that the economy was improving, but rates would be held low for an extended period. Isn't this what got us into a bubble after 2002? Of course you can rationalize why it makes sense, especially if you worry over a repeat of 1937 again: the economy was on life-support, and was growing, but when the extraordinary measures were just slightly pulled back, the economy tanked. Is this then the fate of our overly-stimulated economy? If so, something is terribly wrong with how we are attempting to manage the economy. 

We cannot answer such a question yet - history will tell. But we can ask whether the FOMC statements have been good or poor guidance, particularly on their latest role, managing the economy. If poor, this bodes really badly for following their extrapolations. 

Maybe it would be better to fade them? Big money is made in investing when the herd is all on one side - the smart investor fades the herd. 

CalculatedRisk's assessment of the FOMC statement gives a great example of where fading the Fed makes sense, in this case on real estate. Just consider their FOMC statements, and read the tea leaves of their inability to predict the housing market:

Nov, 2009: Activity in the housing sector has increased over recent months
Dec, 2009: The housing sector has shown some signs of improvement over recent months
Jan, 2010: No comment
March, 2010: Housing starts have been flat at a depressed level
April, 2010: Housing starts have edged up but remain at a depressed level

Comments

[Mamma Boom Boom]

Equity rally to extend for several days...

[Diamond Jim]

A most interesting episode of the Nova science program on PBS in the US aired last night. Its subject was economics and analyzed the great financial collapse we just lived through as well as the Great Depression. One of the people interviewed was Eugene Fama, a professor at the U of Chicago and one of the fathers of the efficient market hypothesis. I don't know whether it was due to selective editing, but he came across as an idiot. A lot of our leading economists today came out of the econ dept at U of Chicago so some of the misdirection by the Fed, Frannie and Treasury may be due to an overly dogmatic, mathematical approach to an all-too human science like economics.

[Michael]

I believe that one of my text books back during my Business School days in the early 80's was written by Eugene Fama, along with a Capital Asset Pricing Model book by William F. Sharpe which highlighted diversification and risk-adjusted investment performance analysis, not too mention the infamous Sharpe ratio. Both of these theories and formulas came from the 10960's if I'm not mistaken. Sharpe was out of Stanford.

[yelnick]

Michael, when I was doing LBO advisory work in the '80s (talk about fun!) I cut my teeth on CAP/M models and all the rest. What attracted me to the Prechterian World after that was the complete lack of thinking about how mass psychology works. These models are all mechanistic, and work reasonably well for mature industries but poorly for dynamic industries.

[Wave Rust]

Never fade Ben 'Bonefish' Bernanke and his Fabulous Fab Fed. Boys :)

At your best, you can only cast
where you saw him last.

He's too quick, and you're too slow.

You risk the most
when you fade the Gray Ghost.

Never fade Bonefish Ben.

:))
wave rust

[Dsquare]

The Fed was created by banksters and allowed to create money (instead of the Treasury), the same year they instituted income tax so the American suckers could pay interest on the money that was created by the Fed when the Treasury could have created it for free. Isn't that right Yelnick?

[yelnick]

Dsqaure, yep. In a midnight passage (shades of the recent healthcare bill being pushed thru technically) the income tax and the reinstatement of the Fed happened in 1913. Andrew Jackson warned us of the perils of a central bank (Jesse's Cafe Americain has the speech posted), so for 75 years we held off. From 1813 to 1913 a nickel cigar cost a nickel, and the Dollar had no overall depreciation or appreciation (altho it did swing +/- 50% in between). From 1913 to (estimated) 2013 it looks like the Dollar will fall 40x, so a nickel then is worth twice a Dollar today. A really terrible record.

One could go back and say that a Dollar was stable for 250 years until 1913. In the 1600s the first northern European Republic was formed, the United Provinces, which became the Netherlands. Their Guilder was backed by gold and stable. The second northern Republic, the United Kingdom, was formed out of the Glorious Revolution of 1688, and it too backed its Pound with gold and held it stable until 1914. The third is of course the United States, and its Dollar was stable from around 1791 to 1913. Not a bad record for gold backed currencies, and done during a 250 year period where their collective economies grew faster than they have since 1913.

We had a truly awful inflation not even five years after the Fed was formed, as bad as we had seen since back after the War of 1812, when we went on and off and on a central bank. We had an even worse inflation in the 1970s after we first cheated on then abandoned the gold standard.

Not a very compelling record for fiat currencies and the Fed.