The Consequences of Easy Money

February 14, 2011

The Federal Reserve's actions in combating the Financial Crisis have had dozens if not hundreds of consequences. However, one of the most profound has largely gone unnoticed by all commentators.

That consequence of the Fed sending the clear message: incompetence pays.

Consider that since the Financial Crisis first hit in mid-2007, the Federal Reserve has pumped TRILLIONS of Dollars into Wall Street. The banks have done what they do best with the money: funnel it into obscene salaries and bonuses.

Meanwhile, all of these firms remain bankrupt (thanks to the suspension of accounting principles no one cares), the underlying issues that nearly took down the system remain in place, and savers and other sensible folks have been fleeced due to US Dollar devaluation and future taxpayer obligations.

Remember, Wall Street is nothing more than an exchange: a place where deals of hundreds of varieties are made. In this sense it's nothing more than a corporate-scale version of Facebook or some other social network platform. That's it.

Wall Street doesn't generate any real goods. It doesn't produce drugs that cure illnesses. It doesn't design cars or vehicles needed to get around. It hasn't invented ANYTHING of real value in decades (unless you count make believe crap like derivatives and CDOs as goods).

No, Wall Street is a services industry. The service it's supposed to provide is that of connecting capital with worthy enterprises in one form or another. However, anyone who's lost money in Enron or the thousands of other firms that are publicly traded despite being outright frauds knows that even this service is BS.

And given that most folks have LOST money on stocks in the last 10 years (assuming stocks ever increased their purchasing power to begin with), as well as the TRILLIONS we've got to pay off in the future thanks to the Fed's bailouts, I'd say it's time the US seriously reconsiders just what purpose Wall Street actually serves in our economy.

Meanwhile, on the other side of the globe… China's paying for Bernanke's policies in different ways. China, as an investment, is important for three reasons. They are:

  • The Chinese economy is believed to be leading the world into recovery
  • The Chinese stock market has lead the S&P 500 for years
  • The Chinese/ US monetary relationship

I've covered #'s 1 & 3several times before and I'll providing an update of my analysis in tomorrow's edition of Gains Pains & Capital. So today we're focusing on #2.

The Chinese stock market has been leading the S&P 500 for years. It bottomed a full four months before the S&P 500 (November 2008 vs. March 2009) during Round 1 of the Financial Crisis.

Similarly, China topped out a full month before the S&P 500 during the market peaks of March/April 2010:

With that in mind, we need to be highly sensitive of the fact that China's stock market peaked in November 2010. Meanwhile the S&P500 (which is fueled every week by Bernanke's Dollar hatred) has continued to plow upwards as though nothing's happened.

This situation has lead many investors to ask themselves: is China no longer a market leader?

I'll be exploring that question in depth in tomorrow's edition of Gains Pains & Capital. In the meantime, I want to point out that China's stock market looks to have just broken the neckline on a Head and Shoulders pattern:

The downside target for this pattern is 32/33, which represents a roughly 19% drop from current levels.

However, be warned that no investment simply goes straight down. Indeed, before we enter a serious collapse for China, we're likely to see it rally up to "kiss" resistance/ its former neckline around 42. If it does "kiss" this line and fails to break above it, then we're likely to see some fireworks sooner rather than later.

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Graham Summers is Chief Market Strategist for Phoenix Capital Research, an independent investment research firm based in the Washington DC-metro area with clients in 56 countries around the world.

Graham’s clients include over 20,000 retail investors as well as strategists at some of the largest financial institutions in the world (Morgan Stanley, Merrill Lynch, Royal Bank of Scotland, UBS, and Raymond James to name a few). His views on business and investing has been featured in RollingStone magazine, The New York Post, CNN Money, Crain’s New York Business, the National Review, Thomson Reuters, the Glenn Beck Show and more.

China has only 2% of its Total Foreign Reserves in gold.