Federal Reserve: Greatest Hedge Fund Ever! But Is It A Central Bank?

by: John M. Mason

Warren Buffett claims that the Federal Reserve has become the "Greatest Hedge Fund Ever!" It has grown itself to $3.0 trillion in assets and it is generating $80 to $90 billion in profits every year! Of course, it is not that hard to do when you can print your own money

One could also argue that the Federal Reserve has ceased to be a central bank. One thing for certain… other than the initial euphoria felt in the stock market and the bond market and the gold market and so forth… the recent actions of the Board of Governors of the Federal Reserve System are not getting very high marks in the press.

The lead editorial in the Financial Times declares "Fed gets it right but says it wrong." In the Wall Street Journal, Jon Hilsenrath's article blares "Fed's Guidance Questioned As Market Misreads Signals." And, one could quote many more such claims of discontent.

So much for openness and transparency and listening to "FedSpeak." I think one thing should be readily apparent from this latest Bernanke gaff…Central bankers are human beings. Furthermore… Economics is not a science! In terms of the first of these statements, human beings work in a world of uncertainty… just like everyone else… and they make mistakes, they don't understand current situations, and they certainly don't know the future.

In terms of the second of these statements, economics is the study of human behavior. It is not an exact science despite the reliance on complex mathematical models and massive econometric studies. Have I mentioned that human beings work in a world of uncertainty, they make mistakes, they don't understand current situations, and they tend to be myopic in their decision-making.

Perhaps central banking… as well as government spending and taxing decisions… has become too reliant on academic research and too reliant on academics. Maybe things like "inflation targeting" and "forward guidance" and other such ideas are nice thoughts when it comes to research papers but it is rather dangerous to initiate such programs untested into the real world.

Note the rising concern about "forward guidance." Samuel Brittan, in the Financial Times writes that "The Bank of England's statements do not give much more of a steer about its plans than a good textbook should." What? Statements about monetary policy are compared to what might appear in a textbook!

The problem is that real people have to live in an environment created by the leaders of the central bank… and the leaders in the federal government. And, the environment they are now living in is not so good. Mr. Bernanke, the world-class economist who is renowned for his research on the Great Depression, seems to have been driven during his tenure as the Chairman of the Board of Governors of the Federal Reserve System by two "ghosts" from his research.

First, his research showed that the Great Depression was as bad as it was because the Federal Reserve did not respond strongly enough and soon enough to lessen the downturn. As a consequence, Mr. Bernanke responded, when he had the chance, by "throwing all the 'stuff' he could against the wall" to see what would stick. He has been called a savior for this policy and a great innovator for creating some 'stuff' that was not on the books before his actions.

Secondly, Mr. Bernanke has had a great fear that there might be a replay of the 1937-38 depression. His response to this was to create something called "quantitative easing." His effort here has been to prevent another banking crisis.

In terms of the success of these efforts… we had a Great Recession but not another Great Depression, and we have not had a significant resurgence in economic growth. Furthermore, people are still leaving the work force and capital utilization continues to fall way below capacity with the implication that maybe the problems in the economy are structural and not cyclical.

In the meantime, Mr. Bernanke and the Fed are helping the wealthy get wealthier and the rest… well get poorer. Here we can point to the fact that the median income in the United States is falling, not rising.

To note, Ralph Atkins writes in the Financial Times: "Central bank easing continues to inflate equities and the Fed's decision gave share prices a new lease of life. But they are moving further and further ahead of the global economic recovery. The FTSE all-world share index rose sharply on the Fed, and is up 15 percent since the start of the year. How long can this last if economies do not accelerate? The clock is ticking." Seems like Mr. Atkins is describing a bubble.

The Federal Reserve may be creating lots and lots of money, like a good hedge fund, for its owners, the federal government, but is creating something a lot more concerning for the rest of us. Bubbles are great on the way up… but, not so great on the way down.

As I have argued in many previous posts… don't fight the Fed. Go with the bubble in your investments for now. But, the other side of the coin in this scenario is… be prepared. Be prepared to get out of the bubble as quickly as you can when it goes the other way.

The economy is not really picking up steam. Profits are there but are not going anywhere. Housing is being picked up by speculators… hedge funds and other wealthy sources… to be 'turned over' at the right time. The caution is… be prepared to get out of the bubble as quickly as you can… because we know historically that when people start to get out… there is a rush for the door.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.