The Federal Reserve said Wednesday, that the economy is so bad it may have to increase its program of buying $85 billion of bonds EACH MONTH. So, tell me again, why is the stock market going up??

In my latest seminar I focused on larger concepts like the broken business model and the next 20 years.   Today I would like to review what Quantitative Easing is and why it drives up the stock market.

Normally, in an economy like today, when few people have money to purchase goods, prices are low and interest rates should be high. Money to loan out is hard to come by and the chances that you will be paid back are low. When you buy a CD or a bond you are loaning money to the bank or corporation so you should be receiving an attractive yield in times like this.  So why is this not the case?

Because the Federal Reserve is “crowding out” the private investor. The fed is buying up almost all of the government bonds available from the banks and giving the money to the banks for free so they can loan it out at a low interest rate and still realize a profit. This artificial “demand” keeps the price of money (or interest rates) low across the economy in hopes money will be borrowed to invest in growth enterprises to revive the economy. This is working fine for the banks since they are earning interest on money that was free to them but NOT working for the economy because very few businesses or individuals are borrowing. They’ve had enough of debt.

The other aspect of “crowding out” is forcing the investor to take on sizeable risk to earn any significant return. Smart investors and pension funds are not falling for this. By making easy money available the Fed is actually inflating the value of investor dollars. When more dollars are available their purchasing power contracts. The Fed hopes this will convince investors to consume more goods thinking they can afford to because their account statements have gone up. It’s an illusion.

Remember the stock market is merely the tail on the derivative dog.  Picking a few good stocks to own is meaningless today. One good company is like a piece of dust in a windstorm. The markets are so complex and interconnected today that risk control is impossible. Everything rises and falls together and without warning. You cannot have a little risk. If you are in stocks or bond funds you are always risking everything.

A headline from the Wall Street Journal today illustrates how terrible the economic outlook really is:

“The European Central Bank cut its key lending rate to a record low and hinted at more-dramatic stimulus measures in a tacit admission that Europe’s economic crisis is getting worse”.

The entire western world is riding on the back of Mr. Bernanke and his balance sheet. How many more trillions of dollars will he be allowed to create to keep it upright?