Why The Federal Reserve's Plan Will Fail

While the extent of the rally has been a little unexpected, the stock market's movement this year has not been surprising.  It was basically predicted by Robert Kiyosaki in his article way back at the beginning of the year ("Doing the Dead Cat Bounce").  Even the great Mr. Kiyosaki was wrong about the timing.  He thought the entire thing would play out by the end of the year, I believe.  It has not, but it will over time.

I've been expecting a market decline for some time now.  History, technical analysis, and fundamentals are all aligning to predict this decline.  It hasn't begun yet and we've seen a remarkable rally since the end of August, but I believe the market is on borrowed time.

The reason why the market has rallied is almost universally recognized at this point.  At the end of September, a hedge fund manager got on CNBC and said that we're in a win/win situation.  Either the economy improves, and the market rallies.  Or the economy doesn't improve, and the Federal Reserve prints more money, and the market rallies.  Either way, we all win.  Well, the past month's data has shown that both the economy has improved somewhat AND the Federal Reserve plans to print more money in an attempt to create inflation/devalue the U.S. dollar.  The result?--a breathtaking rally in the U.S. stock market and basically every commodity on the planet.

So what's next?  How can we lose?  We've got inflation, an improving economy, people spending money.  What can go wrong?

The Federal Reserve already told us what is going wrong.  Their statement released last Wednesday paints a grim picture of the U.S. economy.   Slow growth, higher unemployment, no job growth, stagnant wages, low inflation (the last one's a joke).  And how does the market react?  Up another 250 points or so on the Dow Jones Industrial Average.  Why?  Because the Fed is printing money.

The problem is--they can't print fast enough.  Sure they can create inflation--over time.  But the U.S. Dollar Index has declined 15% or so since July already.  How fast does the market really think those printing presses can go?  High estimates of the Fed's "QE2" show that they could, perhaps, pump (print) $120 Billion per month into U.S. markets over the next several months.  $120 Billion sounds like a lot of money, and it is.  But let's compare that to how much money changes hands worldwide on a daily basis.  Take a look at your favorite large cap stock.  Apple, Exxon Mobil, JP Morgan, Goldman Sachs.  How much money is traded in that one company's stock every single day?  How many millions or billions?  How many stocks, ETFs, commodities, options, currencies get traded every single day?  Now how many countries have stock markets?  $120 Billion a month doesn't sound like such a big number anymore, does it.

The Federal Reserve would like to create inflation.  Guess what?--they have!  Cotton, gold, oil, wheat, silver...you name it.  All way up.  Many at record highs.  What's left to buy?  What's left to go up?  Not much.

If a worldwide recession, depression, or even just a small pause in growth occurs in the near future, securities have no where to go but down.  The Federal Reserve will be powerless to prevent it.  They can't print enough money.  QE2 will be a drop in the bucket.  They're throwing a handful of sand on the beach. 

If you're like me, you've been critical of the Fed, angry that they've created inflation and diluted the value of the dollar.  Gas has gone up at the pump.  Coffee costs more at the grocery store.  It's frustrating, but it's going to end (temporarily at least).  Inflation is over for now.  The Fed is out of ammunition.  There's nothing left in their arsenal and they know it.  QE2 is more symbolic than anything else.  When deflation hits, at least Mr. Bernanke can say that he saw it coming and he tried to stop it.  He's a powerful man, and the Fed does have quite a bit of power.  Too much, in my opinion.  It won't be enough.  It never has been before.  Why should this time be any different?