Bet with Bernanke: The House Always Wins
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Without question, the most significant development for the global economy from The Great Recession has been the emergence of the Federal Reserve under Ben Bernanke as the uber market maker of all time. Market makers profit by matching buyers and sellers. It is a very lucrative role as market makers, in addition to making a commission, are also positioned to know who is buying and who is selling at exactly what price. Having access to this order flow is why brokerage houses, hedge funds, etc... have all prospered to a large degree. The market maker is "The House" in financial markets.
In the wrong hands, access to this information becomes insider trading. In the most egregious case, it created the likes of Bernie Madoff. In a role never been imagined, it now has the United States Federal Reserve Bank as the market maker for monetary policy around the globe.
Federal Reserve Chairman Ben Bernanke has stated publicly that low interest rates will be maintained until at least 2014. Low interest rates are needed for the US real estate market, and thus the American economy to recover. If the United States economy does not rebound, the global outlook is bleak.
Low interest rates are also needed for the Federal Reserve to restore its balance sheet to normalcy. Before The Great Recession, there was about $700 billion on the Federal Reserve balance sheet. Due to the meltdown in the global banking system, the Federal Reserve had to stop it and purchase toxic assets from financial institutions around the world.
In addition to these toxic assets from the private sector, due to the low interest rate environment the Federal Reserve had to initiate Quantitative Easing 2 to finance the budget deficit for the US Government. At such low interest rates, no buyers could be found for US Treasury bonds. Playing market maker, Bernanke found a buyer: the Federal Reserve.
Through an accounting mechanism, the Federal Reserve inflated its balance sheet to purchase about $700 billion in US Treasury bonds from November 2010 to June 2011. As a result of Quantitative Easing 2 and the buying of private sector toxic assets, there is now over $3 trillion on the balance sheet of the Federal Reserve.
So now, in addition to revitalizing the US housing market, Bernanke has trillions in assets that no one else wanted that he has to move. The only lipstick that can be put on these pigs to make them attractive enough to others is that interest rates remain so low as to make the purchase profitable. For that, a low interest rate environment must be maintained globally.
Bernanke has been working this through a number of actions. Swapping dollars for Euro currencies has kept rates from exploding in countries that might attract investors. The extension of Operation Twist by the Federal Reserve, selling short term Treasury bonds to buy Treasury securities with longer terms, has kept interest rates low. In the last year, Quantitative Easing 2 and Operation Twist have been the most prominent marketing activities by Bernanke, but certainly not the only ones.
How effective has Bernanke been as a market maker? Last August, for the first time in history, Standard & Poor's downgraded the US credit rating. Since then, the exchange traded fund for United States Treasury Bonds, iShares Barclay's US Treasury Bond 20+ (NYSEMKT: TLT) has surged by more than 30%; and the exchange traded fund for the US Dollar, PowerShares DB US Dollar (NYSEMKT: UUP), has risen more than 5%.
Recent market action has been even more telling. For the last quarter, the UUP is up 2.27% and the TLT up 14.90%. By contrast, over the same period, the exchange traded fund, SPDR Dow Jones Industrial Average (NYSEMKT: DIA) has fallen by 1.90% and the exchange traded fund, SPDR S&P 500 (NYSEMKT: SPY) is down by 2.86%.
As the saying goes: The House always wins!
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