The Fed Is Stealing from You… and You Don’t Even Know It

Posted by Bill Bonner - Diary of a Rogue Economist & Chris Hunter

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Nihilo ex nihilo fit. Out of nothing, nothing comes. First put forward by ancient Greek philosopher Parmenides in the 5th century BC, Thomas Aquinas and St. Augustine later used this axiom to prove that the universe needed a “first mover,” to get things going. 

Even if the whole thing began with some kind of “Big Bang” moment, it still needed a banger to bang it. 

Who? God, of course. 

We don’t know. But our jaw dropped when we saw how the bangers over at the Federal Reserve have helped add $20 trillion in US household wealth since 2009 – setting yet another new record. The Wall Street Journal reports: 

American’s wealth hit the highest level ever last year, according to data released Thursday, reflecting a surge in the value of stocks and homes that has boosted the most affluent US households.

Ex nihilo? Who cares. It’s there. It’s spendable. 

And yet… what kind of wealth comes from nothing? Is it solid and real, like the earth, the moon and the stars? Or is it something else? 

It is clearly something else. But what? 

The Great Fed Wealth Transfer

Let’s begin by looking at where all that new wealth comes from. Not from the hand of the Almighty, of course… 

We are led to believe that the Fed’s policies are designed to produce a general prosperity; the Fed keeps rates near zero so the entire economy benefits. 

But it isn’t true. Only some prosper. Even the headline in the WSJ says so: “US Wealth Rises, But Not All Benefit.” 

The Fed’s activist policies distort and corrupt the economy. First, prices are bent. Then, taking their cues from bad prices, bad decisions are made. Before you know it, everything is twisted in one direction or another. 

As we noted on Friday, the Fed is largely to blame for the dinosaur houses we see all over the US. Low rates and rising prices tricked Americans into believing that the more house you had the more money you would make. 

We didn’t mention it last week, but factories in China can also trace their genesis to the Fed’s low-down interest-rate policy. Americans were lured to borrow and spend; Chinese manufacturers benefited. 

Record high earnings, record high margin accounts, record high junk bond issuance, record household wealth gains – all are products of Fed policies. 

We quote from the book Paper Money Collapse: The Folly of Elastic Money and the Coming Monetary Breakdown. The author, Austrian School economist and former Wall Streeter Detlev Schlichter, was kind enough to send us an advance copy. Says Schlichter, 

[The financial authorities] can never enhance all economic activity evenly orstimulate‘ the economy in some all-encompassing, general way. Every injection of new money must lead to changes in resource used, to a redirection of economic activity from some areas to others, and change income and wealth distribution. Inflows of new money inevitably change the economy and must create winners and losers.

That $20 trillion in new wealth I alluded to earlier is in the hands of America’s winners. It added little to US GDP… or to Americans’ incomes. It was merely a transfer of wealth. Owners of stocks and houses got richer. Wage earners and savers got poorer.

Take Your Money off the Table

We have some advice for those on the receiving end of the stock market bonanza: Take your money off the table before it disappears. 

After all, it is only a claim on wealth, not wealth itself. And that claim will expire worthless when the Fed changes its policies. The Fed giveth, and the Fed taketh away. 

Either the Fed will taper… ending the bonanza. Or it will lose control of interest rates. And when they rise, all the broken records we have been citing become like broken bottles in a street fight. Somebody is gonna get hurt. 

For the moment, the 12 members of the policy-setting Federal Open Market Committee are more powerful than God. Since the beginning of the universe, it took about 13,798,000,000 years for the market value of all the world’s assets to reach $20 trillion. The Fed’s “Big Bang” accomplished the same trick in only six years – start to finish. 

That does it for us. No more worshipping a guy who has been dead for 2,000 years… or his dad, for that matter. In this Lenten Season, we bow to no man. But for the lady who runs the Fed, the entire economy bends in whatever direction She commands. 



Market Insight:
The Rally in “Junk” 

From the desk of Chris Hunter, Editor-in-Chief, Bonner & Partners

Another effect of the Fed-driven economy is something Bill alluded to last week: the big rally in high-yield, or “junk,” corporate bonds. 

Over the last 10 years the high-yield bond market has returned 131%. This compares to a return of 69% for investment-grade corporate bonds. 

In fact, as you can see from the chart below, junk bonds have been more or less in line the US equities since 2003.

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And with the Fed now leaning heavily on Treasury bond yields, fresh funds are pouring into the high-yield bond sector. 

According to data from Lipper, $559 million flowed into high-yield funds and ETFs for the week ending February 26. That came hot on the heels of $804 million in inflows in the previous week… and $1.45 billion the week before that. 

All that money is chasing an average “junk” yield of just over 5% – or about two percentage points over the benchmark 10-year T-note yield of 2.79%. 

This big influx of money into the junk-bond market is happening at the same time as corporate default rates are on the rise. Ratings agency Standard & Poor’s estimates a 2.5% default rate by the end of this year – up from a default rate of 1.7% at writing. 

That’s not extreme (the long-run average is about 4.5%), but the direction of travel is a concern. 

And just like the rally in US stocks, the rally in junk bonds is heavily dependent on the Fed keeping Treasury yields low. After all, it’s the lack of yields available on relatively safe government bonds (by historic standards at least) that is pushing so many investors out on the risk spectrum in search of yield in the junk-bond market. 

Junk bonds are a popular trade right now. But just like US stocks, much of the easy money has already been made. And a 5% yield, from our perch at least, is poor compensation for the risks involved. 

Think twice before you join the crowd pouring money into junk bonds. Mom and Pop are big buyers. And just like stocks, this is a highly distorted market… and therefore unsuitable for prudent investors.