When Did the Federal Reserve Go Wrong?

the fedThe U.S. Federal Reserve gets a lot of blame when the economy is in a rut...

Spoiler alert: It usually deserves every last word of it.

Under the circumstances, many investors can only wonder if the central bank has always been this way. Perhaps there was a time when it was an agent of good. If so, when did the Fed go wrong?

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Our Chief Investment Strategist Keith Fitz-Gerald - a market analyst with over 30 years of global experience - has a surprisingly simple answer to this question that most policymakers hate to hear...

And that most investors will love.

But before we get to that, we need to establish a simple truth: that the Fed screws up...often.

Just look at the past eight years...

The Fed's Monetary Policy Has Flopped Since the Great Recession

Since the Great Recession in 2008, the Fed has engaged in an unprecedented level of monetary stimulus. At the same time, it's held interest rates near zero for the longest period in the Fed's 103-year history.

The Fed's balance sheet has also ballooned to $4.4 trillion since August 2007, the result of former Fed Chair Ben Bernanke's unconventional quantitative easing (QE) program. The goal of this program, which discontinued in 2014, was to flush the financial system with cash to spur growth in consumer demand.

The Fed currently holds around $2.4 trillion in U.S. debt. Much of this was purchased during the Fed's QE program, which lasted from March 2009 to October 2014.
The Fed currently holds around $2.4 trillion in U.S. debt. Much of this was purchased during the Fed's QE program, which lasted from March 2009 to October 2014.

Yet, despite the Fed's efforts, the results were far from satisfactory. Consumer confidence, while trending upward, has only just reached pre-2008 levels this past year. Annual gross domestic product hasn't been above 3% since 2005. Nearly 40% of Americans are out of the labor force - a 38-year low. Private industry wages are stagnant.

About the only thing that seems to be doing well are the markets. But don't be so easily fooled...

Consider that the stock market participation rate is much lower than it was eight years ago. As of April 2016, only 52% of Americans own stock and mutual funds, compared to 62% back in April 2008, according to Gallup. Home ownership has dropped to a 51-year low.

Asset prices are also incredibly high on the back of low interest rates. As the Dow Jones Industrial Average and S&P 500 hit new highs, net wealth in the United States now tops 500% of national income, according to The Wall Street Journal. Scarily enough, this has only happened twice before: during the 1997-2000 tech bubble and the 2004-2008 housing market bubble.

So, the Fed's recession-fighting efforts seem to have worked, based on stock market highs. But only if you liken the American economy to a sailor stranded on a boat in the ocean. Sure, the economy is above water, but where it really needs to be is on land.

The Fed's disappointing monetary policy results these past eight years are not surprising. From its recession-inciting contractionary policy in the early 1980s to its rapid rate hikes before the 2000-2001 recession, the Fed seems to get things wrong a lot...

But was there a specific point in the past where the Fed took a wrong turn?

Money Morning Chief Investment Strategist Keith Fitz-Gerald knows the answer to that question.

And his answer takes us back to over a century ago...

When the Fed Went Wrong

"The day the Fed went wrong was the day it was created," said Fitz-Gerald. That was on Dec. 23, 1913.

In that history-making moment, President Woodrow Wilson signed the Federal Reserve Act, which aimed to reform the banking industry after a series of financial panics. In particular, the act addressed concerns over the Panic of 1907, which was a financial crisis caused largely by unregulated side bets on the stock market.

This reform, however, was mostly illusory. That's because banking tycoons like J.P. Morgan helped architect the legislation behind the Federal Reserve Act, according to G. Edward Griffin, author of the bestselling book "The Creature from Jekyll Island." You can compare it to how the insurance industry helped write elements of the Affordable Care Act...

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It was the same sort of crony capitalism. You see, the creation of the Fed would help strengthen U.S. currency to aid U.S. banks' quest for global power (and supremacy over European banks). The result was a national banking system meant to serve the financial interests of big, private banks, rather than consumers.

That same criticism has survived over the years, and was affirmed with the "too big to fail" bailouts of the big banks in the aftermath of the 2008 financial crisis.

"When the Fed creates money out of thin air, the risk of failure does not exist," Fitz-Gerald said. "Without the risk of failure, the big banks know they can place one-way bets and not worry about losses because they are literally 'too big to fail.'"

Beyond the self-serving motives behind its creation, the Fed is also terrible at its only job: regulating the American economy.

Since the Fed's creation, the United States has gone off the gold standard, which allows the Fed to control the country's money supply by manipulating interest rates.

This has caused what's called boom-and-bust cycles in the U.S. economy.

Before, when currency was inelastic (meaning there was only a set amount circulating the economy, tied to the value of gold), business cycles were naturalized. That means economic recessions and expansions occurred naturally and healthfully within the U.S. economy. Back then, recessions that were not caused by corruption (like the Panic of 1907) were generally mild.

But when the Fed took over the money supply, it hijacked the U.S. economy. Rather than let business cycles occur naturally, the Fed engineers economic expansions and contractions.

This can leads to big problems - like when the Fed creates so-called economic bubbles. The most recent example is the U.S. housing bubble that popped right before the Great Recession of 2008. Here's the gist: After the 2001 recession, the Fed kept interest rates too low. This led to a flurry of borrowing, which then led to a housing market collapse once the Fed later raised interest rates.

Indeed, the Fed is destined to create havoc in the U.S. economy as long as it's living and breathing. It's been that way since the beginning...

The only solution to the Fed problem is to abolish it altogether.

"The American Fed, as it operates today, is an insult to anybody who believes in economic and political freedom," Fitz-Gerald says. "In an era of globally linked finance, the very concept of the Fed is an abomination."

The Bottom Line: Yes, the Fed is ineffective. But as an investor, that means opportunity. Asset prices are going to go higher -- and you stand to gain.

"Get over any emotional ties you have to the Fed and get prepared to make money," Fitz-Gerald said. "It's better to be long than wrong."

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