1 Simple Fact – The Fed & Central Banks, Why They Are Powerless To Help Markets

The Fed is reactive. That’s it, it is that simple.

This post is a bit of a ramble so bear with me, it’s the first time I think about this subject.

Ben Bernanke has come out with another statement today but ultimately The Fed is always behind the curve, always.

The Fed is always responding to the markets, whether it be the value of the currency, the yield on treasuries whatever. The Fed is always reacting.

Take the Feds decision today. They have spent the last month at least working out what they are going to do about monetary policy, I’m sure they have hundreds of economists working on this stuff day and night.

So, the Fed told the markets what it was going to do, the markets immediately adjusted the to take into consideration what the Bernanke has said and immediately all the data the Fed used to plan its policy and old and irrelevant, the market changed.

To me, it is absolutely bananas that the Fed thinks it is controlling the markets. It is obviously impossible. They have data that they plan their policy around but as soon as they announce their plan of action the goal posts change, everything that they based their decision on is instantly out of date when they announce it.

The market is constantly adjusting to its environment. All of the Feds predictions are based on historical data, the market works on current data.

The market is working to a completely different set of data to the Fed. How the Fed thinks it can manipulate the market is absurd to me.

I think I am labouring the point here but I will continue with an analogy.

The cost of government borrowing has been increasing. The Fed decides to “inject” liquidity into the market. As soon as this is announced the market adjusts to the new reality which makes the data that the decision was based on irrelevant.

The Fed then analyses the what has happened after its last announcement, the Fed makes another announcement and the market adjusts again.

The market is always valuing commodities at their true value according to reality. The Fed is making decisions based on what it thinks things should be valued at which is not based on reality.

In short The Fed is always responding to the actions of markets. And it is not responding to the motives for the actions of the market.

The only way The Fed can be effective is if it responds to reality and not to the actions of the markets.

But hold on, isn’t that the job of the market? Isnt the market supposed to respond to reality?

So if the market is responding to reality what is the purpose of the Fed exactly?

If the market is responding to reality why is The Fed necessary?

And another good thing about the markets is that everyone in it knows that no firm in the market is perfect. Which means there is balance to the decision-making. Whereas The Fed is just one view.

I think the best way to visualise it is a teacher with average intelligence trying to teach a class of geniuses.

The only thing the teacher can do is have a consistent policy regardless of what the children are doing so the children have a stable environment in which to develop. For the teacher to try to manipulate the children by constantly changing his or her policy is only going to lead to confusion amongst the kids. They will be spending all their time adjusting to the different behaviours of the teacher rather than developing their understanding of reality.

It would be idiotic of the teacher to believe he/she can manipulate the actions of all the children in the class given that she has no idea why they are acting the way the are acting.

I am absolutely positive someone else can put my thoughts into writing in a more coherent way, but I thought I would take a stab at explaining the market-Fed dynamic as well as I can at the moment, feel free to run with it

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