Why Does the Stock Market Go Up When the Fed Prints Money?

As expected, the Federal Reserve Bank, led by Chairman Ben Bernanke, just announced another round of quantitative easing (QE) to try and jumpstart the economy. Quantitative easing, as I discussed in my last post, can include buying bad debt with newly printed money.

Now, anyone can see that the Fed buying bad debt with money made out of thin air is a risky game. But the markets responded favorably to the news. Stock markets jumped, gold went up, commodities rallied. What's going on? Why do markets rally when money gets printed?

What the government would like you to believe is that QE promises to improve the economy and so markets are moving in anticipation of that improvement. Happy days will be here again!, they want you to think. That might be a reasonable expectation if this were a normal business downturn. But it isn't. The real reason markets rally at the news of more QE is not expectation of prosperity, but of another bubble.

For the last twenty years or more, the central banks of the world have been blowing bubbles. They print too much money to try to goose economies, and much of that money finds its way into stocks and other markets. They get inflated and eventually pop. This is an all-to-familiar pattern. In the last fifteen years we've had three major bubbles. The stock market bubble, the commodities market bubble and the real estate bubble. Now the Fed is trying to blow up another bubble. That's all QE3 can really accomplish.

When government apologists are asked what causes these bubbles, they invariably answer something like "investor excess" or "Wall Street greed." And make no mistake--Wall Street is greedy. But Wall Street cannot go crazy with money unless the Fed makes money abundantly cheap. If Wall Street are the drunks, the Fed is the bartender. Sure Wall Street should drink more responsibly. But if you are at a party and the bartender keeps serving up free drinks, doesn't he bear some responsibility for the mayhem that ensues? Of course he does. In the same way, the Fed is ultimately responsible for the excessive, speculative bubbles we've witnessed.

The problem is the Fed can't come up with any solutions to our current economic funk other than printing more money. But the funk was caused by too much money in the first place! Money became so cheap, and credit became so easy, that people borrowed rather than saved, and lived in the expectation that soaring stocks and real estate equity would be their "savings." That is a bubble economy, and it amounts to dancing with the Devil.

Now the Fed is still printing money and putting it in banks--only people aren't borrowing it. They are starting to figure out that more debt isn't the answer. But the banks aren't just going to sit on that money. So what will they do with it? They'll use it to buys stocks and commodities and anything they think might get a return, which will inflate those markets. But that is just another bubble. It's not real prosperity. Nothing is being produced--just more printing, borrowing and market manipulation.

And since so much money is available, interest rates are next to nothing. So in order to try to stay ahead of inflation (that is caused by all the money printing!), people are compelled to play the stock market/real estate game, subjecting their hard-earned money to the risk of another collapsing bubble.

And collapse it will--ending badly, again, for most people.

So get out your dancing shoes. The Devil wants another round on the dance floor and the drinks are on him. The Alka-Seltzer, however, you'll have to pay for yourself.