Is Fed Money Fake? Investors Make It Real

Quantitative easing does seem to boost markets (at least for a bit).

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With more dollars in circulation, the U.S. currency's value declines versus other currencies, and that immediately lifts the dollar value of foreign sales. Add to that all the favorable impacts of lower interest rates on housing, car purchases, and business investment, and there is an even wider impact.

But the effects of easing are nearly always short-lived, past cycles have shown. Through all of the previous rounds of monetary stimulus since the 2008 financial crisis, banks have been injected with record levels of virtually interest-free cash. But lending and investment have sagged because potential borrowers are not in a rush to spend on their businesses, since demand for products they sell has been weak.

The same could be said for stocks. Charles Biderman, chief executive officer of TrimTabs Investment Research, said in report that after each Fed action since 2009, stocks have surged and then sagged. Based on the Standard & Poor's 500:

  • Easing 1 (March 2009): stocks rose 50 percent before a 20 percent drop.
  • Easing 2 (August 2010): stocks rose 40 percent before a 20 percent drop.
  • Easing 3 (April 2011): stocks rose 30 percent before an 11 percent drop.
  • Breaking the downward cycle. The Fed intends to do more than just prop up the price of stocks with the billions it spends. "It will have an impact," says Germain. "But the question is whether it will have the desired impact."

    The risk is that cheap money will fuel general inflation or produce the next round of asset bubbles as more cash chases fewer goods and lifts prices. Also, it's worth noting that the weaker dollar mentioned above is not, by and large, a good thing for average American consumers.

    [See 6 Not-So-Great-Alternatives to U.S. Treasuries.]

    The Fed is betting its actions will afford enough of a buffer for a stronger real economy to replace the artificial stimulation. The housing market could be the first to benefit, and its recovery is critical, not least because it was the collapse of that sector that triggered the economic depression of 2008. Right now, housing is a bit of a bright spot, and it has been in a recovery mode for much of the year.

    "The real estate recovery is happening already, and would do so with or without the Fed," says Hugh Johnson of Hugh Johnson Advisors. "All of the housing numbers are getting better and better."

    He disputes a widely held view that housing will remain relatively depressed until employment recovers. "Housing historically tends to turn up before the rest of the economy," he says. "If housing continues to improve, those that do have a job and a house start to feel better and there is a dynamic created. People start to feel better and start to spend more."

    But more importantly for market watchers is the question of whether Bernanke's cash infusion can balance out the impact of the first earnings downturn since 2009, which analysts are forecasting in the months to come. Maybe not. But the Fed chairman vows to outlast the negatives, whatever they may be, saying in his policy statement that the Fed money will flow "for a considerable time after the economy strengthens."