Massive Dow uplift

Good morning from cloudy Miami!

You can’t help but have noticed the massive uplift in the value of the Dow Jones Industrial Averages yesterday. In case you missed the surge, the DJIA was up 193.45, or 1.8%!

The first question that naturally pops into my mind is: why? Why now? What suddenly changed to convince folks that yesterday was THE time to buy?

Presumably the answer was comments made by the head of the Federal Reserve Bank in Chicago, Don Evans, and by Fed Chairman himself, Ben Bernanke. Both men indicated that the Fed is prepared to inject economic stimulus into the economy, read: money.

I have said on the blog a lot lately that the Fed could scarcely do much to prop up the economy through interest rate manipulation. That’s because interest rates are near zero anyway and very few folks are wanting to, or able to borrow money even at levels that basically constitute “free money.”

So what is the Fed proposing to do now? Technically they are going to buy back US Government securities in the open market. This will pump cash directly into the economy. Because more money in the economy is always an inflationary force (more dollars chasing the same set of good = higher prices) you have to assume the Fed is not too afraid of inflation at this point. This issue aside, what about the most important question: will this work?

It is my intuition that this strategy on the part of the Federal Reserve will work, but not because it actually will do anything tangible, but that psychologically it reassures people that the Federal Reserve is prepared to parent its economic child through its post Great Recessionary nerves. Amen!

While I am glad that the financial markets are back to levels we last saw in May and back to where I said I felt it was prudent to buy, I am not a fan of throwing more money at the economy. The bedrock of real economic growth is innovation. Economic growth that is inflation driven (think: the too low interest rates that drove the real estate bubble and planted the seeds for the Great Recession) is ephemeral and a chimera. Only if people and businesses take these additional funds and invest them in innovative, high-return, long-term projects will the economy benefit. But at interest rates near-zero right now, folks aren’t doing that. It seems more likely to me that people will instead spend these extra funds the way they spent the “spigot-is-open” funds of the last decade: buying stuff.

In short, for this strategy to work the Fed has to be willing to raise interest rates to take the excess cash out of the economy before another bubble develops. Unfortunately, there is no evidentiary proof over the last decade that anyone at the Fed knows how to, or is willing to, do this.

In conclusion, I will be paying close attention to the future movements of the financial markets as folks continue to digest this news.

Jason

Author of The Intuitive Investor: A Radical Guide for Manifesting Wealth