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Policy: Economy

America is addicted to the Fed's false economy

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Op-Eds,Fiscal Policy,Economy,Federal Reserve,Analysis

Anxiously awaiting the next announcement? Do you feel like you need to have the information? Does the thought of not receiving the news you want give you chills, tremors, and headaches? If you answered "yes" to these questions, you're probably addicted.

While these feelings might sound like the symptoms of a drug or alcohol addict, they describe the dangerous dependency investors -- both large and small -- have to the words uttered from the Federal Reserve.

In a true free-market world, the stock market serves as a gauge for the strength of the economy. If the market is rising, then it's generally because employment is strong, companies are growing, entrepreneurs are innovating, and private capital is channeled toward the most promising investments.

If the market is declining, then you'll likely see trends of companies laying-off people, corporate earnings disappointing, or businesses closing shop. If there is a disconnect between the markets and the economy, then something is wrong.

Folks, something is wrong. Eight times each year, the Federal Open Market Committee, a committee of 12 members comprised of seven Federal Reserve governors and five regional bank presidents, meets to determine what policies the Federal Reserve will implement to bolster a healthy economy -- raise or decrease interest rates, sell bonds to head off inflation or even create more money.

Investors make decisions based on these announcements -- before and after -- by buying or selling stocks, hedging portfolios, or investing in sectors of the economy they feel will respond most significantly to Federal Reserve action.

A paper by the Federal Reserve Bank of New York examines the effects of the 24-hour window before announcement of the Federal Open Market Committee's decision on monetary policy, and the results are startling.

In fact, since 1994, when the committee began announcing its decisions to the public around 2:15 p.m. Eastern time, 80 percent of all yearly excess stock returns were realized during this short period of time before the committee's announcement. This statistic is a tell-tale sign of addiction.

The mirage of Fed-fuelled prosperity is corrosive to a healthy economy because it leads people to make financially destructive decisions from which they can't recover.

A rising stock market serves as an indicator to people that things are going well--a signal that the future is sunny and the economy will keep growing. Grandpa may decide to buy a new car, or your favorite teacher may decide to retire early because her 401(k) is doing well, and she expects the rise to continue. This is all well and good, until the true strength of the economy reveals itself.

Like a house, wealth built on cards will eventually crumble. Grandpa now has a car he can't afford, and your teacher will struggle to meet her expenses because her nest egg has shrunk in value -- real decisions based on illusory wealth.

Similar to bulked-up baseball players who accomplish superhuman feats, our financial system is based on Federal Reserve-supplied steroids and not market-based growth.

We cannot depend on the addicts to help themselves, which is why our entire financial system needs an intervention. The Federal Reserve needs to be constrained to its original mandate: managing inflation.

I certainly do not envy the task facing the 12 members of the Federal Open Market Committee, but asking 12 mere mortals to orchestrate the world's largest economy just doesn't seem like a good idea.

Garrett Ballengee is a policy analyst for the Economic Freedom Project, focusing on the issues of monetary policy, economic freedom and human well-being.

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