American Investment Services, Inc.

Disciplined, Diversified, & Cost Effective

Aug. 2013 – The Fed and Wall Street

Lowell Harriss, the late great economist and former Chairman of the AIER Board of Trustees was known as much for his humility as for his knowledge
of economics. At a recent event commemorating his mentor’s life, author and financial commentator Ben Stein recalled that in his lectures Professor Harriss
was never reluctant to admit that with regard to many areas of economics “we just don’t know.”

If only such humility prevailed among the world’s central bankers and financial regulators.

Very few economists have faith in central planners and instead defer to the wisdom of markets and voluntary exchange to set prices and coordinate the delivery of goods and services. Yet these principles are ignored when it comes to monetary policy and interest rates. These key determinants of financial market returns, and indeed of general economic prosperity, are in fact left in the hands of a few anointed experts.

The Fed’s power to affect interest rates in particular wields enormous influence over financial markets. Recently, investors have been whipsawed by every utterance from the Fed suggesting when or by how much the central bank might begin “tapering” from its massive bond buying program. These sentiments are amplified by the financial media, where commentators regale us daily regarding rising interest rates and the timing and magnitude of a corresponding collapse in the bond market.

Yet, as John Cochrane of the University of Chicago has pointed out 1 regulators’ track record for diagnosing and defusing financial “bubbles” is not great, to say the least. The Fed missed the boat on the tech stock run-up of the 1990s and the real-estate collapse that began in 2007. European bank regulators failed to circumvent a sovereign debt crisis, and U.S. regulators encouraged the housing boom by pushing banks to lend to high-risk borrowers.

AIER has long pointed to the virtues of sound money as well as to the dangers inherent in discretionary monetary regulation. While prospects for a resumption of a “gold standard” may appear remote, we submit that the world would be well-served if policymakers were to reconsider several transparent, rules-based approaches to monetary policy, such as strict adherence to a targeted rate of growth in a monetary aggregate, or to a specific rate of price inflation. Milton Friedman asserted that the Fed’s open market operations could be abolished and replaced by a computer. 

There will always be among us those who think they are smarter than the markets. Money managers who claim the ability to outguess markets wield the same hubris as those who regulate our financial system and our money supply. Both have failed demonstrably. Investors should not try to anticipate the Fed or listen to the clamor from the financial media; instead they should focus on factors within their control, the heart of which is adhering to a well-defined allocation plan.

Also In This Issue

The Art Of Letting Go
Fixed Income Investment Strategies
The High-Yield Dow Investment Strategy
Recent Market Statistics
The Dow Jones Industrials Ranked By Yield
Recommended Investment Vehicles