According to Art Cashin, director of floor operations at UBS Financial Services, the central bank's effect on the financial system has worrying parallels to the period leading up to the Great Depression.
"The weak data that we've gotten, particularly the
The problem for many hedge funds, Cashin said, is that a number of them bet that inflation would hit the markets after continued easing from the Federal Reserve, but the expected move hasn't materialized. "They've looked and said, 'Gee the Fed is printing money like crazy, that's got to be inflationary,' and ordinarily it has been."
However, Cashin said, much of the Fed's new money hasn't found its way to the economy, as financial institutions—the major recipients of easy money—are too nervous to put the capital to work. This nervousness is reflected in nearly $2 trillion of excess free capital reserves, he explained.
Cashin offered an analogy: "Ben Bernanke flies over your house, he drops $1 million on your lawn. You're so nervous that you put it in your garage. That's what's happening in the banking system. ... The money is not being lent or spent, so that can't be inflationary."
"Unfortunately some of the history is shown in the period in the early 1930s. The Fed did some of the same things we're talking about now: They got pushed by the White House, they pumped money into the system; money backed up and stayed in the banking system," he said. "They then interpreted that incorrectly and said 'money must be very easy.' "
In the 1930s, the Federal Reserve followed those actions by raising interest rates (a move generally considered a mistake by economists), Cashin said. Though Bernanke is likely to avoid making the same costly error, he added, "he's had the same first result, which is the money backing up."