When do we get off this treadmill whereby central banks believe it's their responsibility to not only maintain price stability and maximize employment, but also to boost asset prices (thereby creating new systemic risks)?
The Federal Reserve's assessment of "inflation" is flawed. Not only does the Fed essentially disregard the prices of food and energy (which disproportionately affects low- and moderate-income consumers), but the central bank also fails to consider asset-price inflation.
Virtually everyone agrees that the Fed's easy-money policies have directly contributed to a huge rebound in stocks and housing prices. In fact, aggregate household net worth has increased by $26 trillion to $82 trillion (an all-time high) since the first quarter of 2009. But the Fed's goal was not simply to make rich people more rich (which they did). Rather, they are operating under the misguided assumption that higher asset prices will, by some miracle of trickle-down economics, lead to plentiful jobs and higher incomes for the masses.
The Fed's current policy mistakes are eerily reminiscent of the ones made by Chairman Greenspan in the early 2000s. Following the implosion of technology stocks in 2000-2001, Greenspan kept the fed-funds rate at 2 percent or lower for the following three years. Low interest rates, along with deterioration in mortgage underwriting standards, led to huge increases in housing prices. We all know how that turned out.
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The only thing that makes it worse this time is that Chairman Bernanke (and now Chair Yellen) are making no attempt to veil this strategy. They have come right out and told us (fairly regularly) that they are targeting stock prices as a way to generate better economic growth. We found those comments troublesome then, and we still find them troublesome today. In our view, the Fed has no business influencing stock prices.
So now we find ourselves in the familiar position of advocating for an end to quantitative easing while still believing that the Fed may not follow through with its plan to end QE by the end of the year. Why?
Because the Fed has conditioned investors to expect action following any and all episodes of stock volatility. Ebbs and flows in stock prices (i.e., volatility) are supposed to be the inevitable trade-off for the high relative returns that equities provide. However, each minor dip in stock prices over the past few years has been followed by reassurances by the Fed that they stand by to offer support. At this point, they need not even give us the verbal reassurance anymore. Investors just expect that the Fed will be there if and when prices fall too much.
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Our worry is that, notwithstanding the massive increase in stock prices over the past five years, a large contingent of individual investors has become extremely distrustful of the stock market. This lack of confidence is related to a belief that the game is rigged. In my most recent book, "Restoring Our American Dream," I argue that it is imperative that we reconnect culpability and consequence. We have to ensure that the average investor has faith that the cards are not stacked against him or her. To this end, we applaud Attorney General Eric Holder for his ongoing prosecution of those responsible for misleading investors prior to the financial crisis.
However, the work doesn't end there. We also must get off this incessant treadmill of inflating asset prices as a way to stimulate economic growth. These successive booms and busts do not project the market stability that individual investors so desperately seek.
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The Fed's unwillingness to extricate itself from the markets is a very worrisome trend that has had devastating outcomes in the not-too-distant past. Effectively, the central bank is attempting to induce inflation in the broader economy by boosting asset prices by tens of trillions of dollars. Nothing very positive can come out of this experiment. The best case is that baby boomers, wary of the stock market, will have to accept much smaller returns going forward if and when they begin to embrace stocks again. The worst-case scenario is that another bubble will burst. Either way, we don't believe the Fed's continued meddling will end well.
We remain invested but defensive. There are plenty of land mines still lurking out there. Stick with quality, and don't swing for the fences.
Commentary by Michael K. Farr, president of Farr, Miller & Washington and a CNBC contributor.
