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January 3, 2013

The Fed Kicks the Can Right Past the Evan’s Rule

What defines “real”?

The search for authenticity is occasionally embarked upon by the individual in an effort to find some kind of existential meaning. The attentive gourmand strives for real food, the wife for real love, and the artist for real expression. But how to define this so-called real is always fraught with ambiguity. How much processing can food take before it loses its authenticity? How much privacy must an artist share to achieve the real? In the realm of money, the definition of real is much easier. You either have it or you don’t. All the platitudes about security, wealth creation, and staying the steady course are worthless if you have nothing in your bank account. You can’t eat a platitude and you can’t retire on a soft spoken promise. Money breaks down “real” to an actual number that you can see on a statement every month. What does this have to do with the Fed? The Fed has a metric that it lives by. It’s called the stock market. Whenever the Fed makes a pronouncement, headlines start blaring across the web about how the stock market reacted. And it seems that the markets do indeed give some credence to whatever is being currently proclaimed by the Fed. The most recent round of this symbiotic interaction can be seen with the proclamation of the Evan’s rule. The Evan’s rule is an attempt to set specific limits as to how long the Fed should be overly generous in its monetary policy. Of course the economy needs stimulating, but at what point does the stimulation become counterproductive? Chicago Fed President Charlie Evans has proposed a cutoff at 6.5 percent unemployment or 2.5 percent inflation. In the short term, however, the Fed’s easing should continue on unabated. Enter the naysayers. Although the Evan’s rule seemed to carry the day, a number of Fred members felt the easing should stop much sooner. The Fed minutes included the following line: “Several others thought that it would probably be appropriate to slow or to stop purchases well before the end of 2013, citing concerns about financial stability or the size of the balance sheet.” In other words, it’s time to start tightening the belt. So did the market respond to the Fed’s inherent floppiness and vague murmurings as to the end of the free lunch? It certainly did. There was an immediate downtick. If you have your wealth invested in the market, then you most probably suffer an ever increasing series of minor heart failings every time the Fed makes a pronouncement. Ditto for the European Union. Double ditto for Congress tax negotiations. A market based portfolio is in essence an investment plan that is not tied to any real value. The price of your shares is not dependent on the profits of the company, but rather on the world’s perceived notions of profitability and the current economic state. If you’re a gambler, it’s possible that you can pull off a market swing and pull out in the black. However, if you’re looking for the consistent “real”, you’ll just have to look elsewhere.

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