 Why the
Fed is Such a Lousy Wizard of Oz
Susan C. Walker
Elliott
Wave International
Sep 7, 2007
Central bankers who "follow
the yellow brick road" end up in Jackson Hole, Wyoming,
every Labor Day weekend for their annual symposium sponsored
by who else? the Kansas City Fed. (Who can forget
Judy Garland saying to her little dog, "Toto, I've got a
feeling we're not in Kansas anymore," in the 1939 movie,
The Wizard of Oz?)
The Jackson Hole Resort serves
as the Federal Reserve's equivalent of the Emerald City, as Fed
governors and presidents meet with central bankers and economists
from around the world to discuss economic issues. This year,
the symposium focused on housing and monetary policy. Usually,
the Fed chairman kicks off the symposium and, this year, the
new chairman, Ben S. Bernanke, did the honors. He closed his
speech with these words:
"The interaction of
housing, housing finance, and economic activity has for years
been of central importance for understanding the behavior of
the economy, and it will continue to be central to our thinking
as we try to anticipate economic and financial developments."
Then came the other speeches.
And it seems that some of the guests in Emerald City were waiting
for their chance to pull back the curtain and prove that the
Wonderful Wizard of Oz isn't such a wizard after all. Bloomberg
reported that "Federal Reserve officials, wrestling with
a housing recession that jeopardizes U.S. growth, got an earful
from critics at a weekend retreat, arguing they should use regulation
and interest rates to prevent asset-price bubbles." Apparently,
one academic paper presented at Jackson Hole graded the Fed an
'F' for the way it has handled the repercussions from the rise
and fall of the housing market.
Truth be told, these folks
are a little late to the table as critics of the Fed. We're glad
they're joining us, but here's what they still haven't learned:
It isn't because the Federal Reserve messes up by allowing credit,
asset and stock bubbles to form that it's not a wizard. The Federal
Reserve isn't a wizard for one particular reason that it doesn't
want anybody to know and that is that the Fed doesn't lead
the financial markets, it follows them.
People everywhere want to believe
in the Fed's
wizardry. But all this talk about how the Fed will be able
to help the U.S. economy and hold up the markets by cutting rates
now is as much hooey as the Wizard of Oz promising Dorothy, the
Scarecrow, the Tin Man and the Cowardly Lion that he could give
them what they wanted: a return to Kansas, a brain, a heart,
and courage. Because when the Fed does do something, it always
comes after the markets have already made their moves.
If you don't believe it, you
should look at one chart from the most recent Elliott Wave
Financial Forecast. It compares the movements in the Fed
Funds rate with the movements of the 3-month U.S. Treasury Bill
Yield. What does it reveal? That the Fed has followed the T-Bill
yield up and down every step of the way since 2000. And the interesting
question becomes this: Since the T-bill yield has dropped nearly
two points since February, how soon will the Fed cut its rate
to follow the market's lead this time?
[You can see this chart and
read the Special Section it appears in by accessing the free
report, The
Unwonderful Wizardry of the Fed.]
We've got our own brains, heart
and courage here at Elliott Wave International, and we've used
them to explain over and over again that putting faith in the
Fed to turn around the markets and the economy is blind faith
indeed.
"This blind faith in
the Fed's power to hold up the economy and stocks epitomizes
the following definition of magic offered by Teller of the illusionist
and comedy team of Penn and Teller: a 'theatrical linking of
a cause with an effect that has no basis in physical reality,
but that in our hearts ought to be.'" [September
2007, The Elliott Wave Financial Forecast]
Because, you see, what makes
the markets move has less to do with what the unwizardly Fed
does and more with changes in the mass psychology of all the
people investing in those markets. The
Elliott Wave Principle describes how bullish and bearish
trends in the financial markets reflect changes in social mood,
from positive to negative and back again. To extend the metaphor:
The Fed can't affect social mood anymore than the Wonderful Wizard
of Oz could change the direction of the wind that brought his
hot air balloon to the Land of Oz in the first place.
As our EWI analysts write,
"With respect to the timing of the Federal Reserve
Board rate cuts, we need to reiterate one key point. The market,
not the Fed, sets rates." Being able to understand
this information puts you one step closer to clicking your ruby
red shoes together and whispering those magic words: "There's
no place like home." Once you land back in Kansas, your
eyes will open, and you will see that an unwarranted faith in
the Fed was just a bad dream.
Sep 7, 2007
Susan C. Walker
Susan C. Walker writes for Elliott
Wave International, a market forecasting and technical analysis
company. She has
been an associate editor with Inc. magazine, a newspaper writer
and editor, an investor relations executive and a speechwriter
for the Federal Reserve Bank of Atlanta.
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