The Connection Between the Fed and the Stock Market

I have made this point in several venues and on the pages of the Lara-Murphy Report for years, but some people may be new to this perspective. In the chart above, we see that the “monetary base”–which measures the total amount of currency held by the public, plus the electronic reserves that banks have on deposit with the Fed–has moved in lockstep with the S&P500 index since 2009.

This correlation underscores our view that the alleged recovery in the US economy, and the surge in stock prices, is built on quicksand. You don’t foster prosperity by having the central bank create money “out of thin air” in order to buy government debt and mortgage-backed securities.

Some wags have looked at the above chart and said, “Ah, so you guys should be in favor of QE4, right?” No. Each round of asset purchases merely digs us into a deeper hole, and will make the eventual reversal that much more painful. At some point, world investors will stop viewing Treasuries and the USD as “safe havens” and then the Fed will truly be out of options. If the people in charge have common sense, they will stop before that point. Thus far, it seems that Janet Yellen has assumed the role of the central banker who takes the punch bowl away and ruins the party.

For more on this topic, read up on Austrian business cycle theory.