Ignore the Markets (and the Fed), the Economy Is Doing Fine

BernankeMarkets1.jpg

You could be forgiven for missing the latest installment of market panic over the past ten days. It came and went like a summer thunderstorm -- passing over the global financial landscape quickly and violently. But unlike meteorological events that inflict actual harm, the sharp gyrations of financial markets have increasingly less relationship to real-world economies and exist in their own never-never land of self-fulfilling prophecies and conventional wisdom.

The proximate cause of the swoon was June's monthly statement from the Federal Reserve and Ben Bernanke's comments that the Fed might taper its purchases of bonds sooner than many market players had anticipated. The exact quote wasn't exactly dramatic (so few Fed quotes are!):

"The Committee currently anticipates that it would be appropriate to moderate the monthly pace of purchases later this year. And if the subsequent data remain broadly aligned with our current expectations for the economy, we would continue to reduce the pace of purchases in measured steps through the first half of next year, ending purchases around midyear."

The hint that the Fed would slow or even halt its monthly purchases of $85 billion of government and mortgage bonds was enough to send bond yields substantially higher and stocks substantially lower. It also made market bears substantially cockier. The most notable example was the ever-opinionated Rick Santelli on CNBC whose weekly rant took Bernanke to task not just for how he communicates, but for soft-pedaling the weak and tenuous U.S. and global financial system.

The bond market response was particularly dramatic. Yields on U.S. 10-year Treasuries went from just over 2 percent to 2.6 percent, still historically low but a substantial move in a short time. Emerging market bonds were even more eviscerated, and the ripple effects for pension funds and retirement accounts will be felt for some time as the value of supposedly safe bond holdings declined as much or more than supposedly riskier stocks.

There were other factors, including renewed concerns about China's credit situation, but in essence the gyrations in the markets reflect nothing other than the gyrations in the markets. An undue amount of the volatility stemmed from high-frequency traders (whose algorithms execute trades by the millisecond) and assorted speculators, as well as professional investors who have watched from the sidelines as stocks have gone up and have been waiting to make money from them going down.

In fact, many professionals in both the bond and stock markets have been convinced that the only reason that stocks and bonds and a host of financial instruments have been strong is because of easy money provided by both the Federal Reserve and by other central banks around the world. Former Fed chairman William McChesney Martin famously said in the mid-20th century that the role of the Fed and central banks was to provide enough money when times were tough and then "to take away the punch bowl just as the party gets going." That phrase has become the cliché of choice for investors. Throw a dart at any set of commentary from fund managers and traders over the past year, and that phrase or a variant occurs time and again. Type the words "Bernanke Fed punch bowl" into Google and you get tens of thousands of results.

Presented by

Zachary Karabell is Head of Global Strategy at Envestnet, a financial services firm, and author of The Leading Indicators: A Short History of the Numbers that Rule Our World. More

At River Twice Research, Karabell analyzes economic and political trends. He is also a senior advisor for Business for Social Responsibility. Previously, he was executive vice president, head of marketing and chief economist at Fred Alger Management, a New York-based investment firm, and president of Fred Alger and Company, as well as portfolio manager of the China-U.S. Growth Fund, which won a five-star designation from Morningstar. He was also executive vice president of Alger's Spectra Funds, which launched the $30 million Spectra Green Fund based on the idea that profit and sustainability are linked. Educated at Columbia, Oxford, and Harvard, where he received his Ph.D., he is the author of several books, including Superfusion: How China and America Became One Economy and Why the World's Prosperity Depends on It (2009), The Last Campaign: How Harry Truman Won the 1948 Election, which won the Chicago Tribune Heartland Award, and Peace Be Upon You: The Story of Muslim, Christian, and Jewish Coexistence (2007), which examined the forgotten legacy of peace among the three faiths. In 2003, the World Economic Forum designated Karabell a "Global Leader for Tomorrow." He sits on the board of the World Policy Institute and the New America Foundation and is a member of the Council on Foreign Relations. He is a regular commentator on national news programs, such as CNBC and CNN, and has written for The Wall Street Journal, Newsweek, Time, The Washington Post, The New Republic, The Los Angeles Times, The New York Times, and Foreign Affairs.

Google Street View, Transformed Into a Tiny Planet

A 360-degree tour of our world, made entirely from Google's panoramas

Join the Discussion

After you comment, click Post. If you’re not already logged in you will be asked to log in or register.

blog comments powered by Disqus

Video

Google Street View, Transformed Into a Tiny Planet

A 360-degree tour of our world, made entirely from Google's panoramas

Video

The 86-Year-Old Farmer Who Won't Quit

A filmmaker returns to his hometown to profile the patriarch of a family farm

Video

Riding Unicycles in a Cave

"If you fall down and break your leg, there's no way out."

Video

Carrot: A Pitch-Perfect Satire of Tech

"It's not just a vegetable. It's what a vegetable should be."

Video

The Benefits of Living Alone on a Mountain

"You really have to love solitary time by yourself."

More in Business

From This Author

Just In