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Everything You Think You Know About the 'Big Bad Fed' Is Wrong


These five common misconceptions about the effects of QE and how monetary policy works put investors at risk.

4. QE is the reason we have high oil/gasoline prices. This very deeply held view is just as deeply mistaken. As the chart below shows, post crisis/post QE, oil prices on average (red line) have gyrated around $80 to 90 per barrel with no ascending trend. The ascending trend came well before we knew what QE even was, in the 2002-2007 period. And the most rapid phase of its rise took place as the Fed was raising rates from 2004-2006.

Paying high prices makes all of us angry, and it feels good to have someone to lash out at, but, alas, reality disagrees.

What, then, caused the rise in the price of oil? In brief, the rise of China after it joined the WTO in 2002 and investor allocations to commodities as a "new asset class," with trend followers, speculators, and prop desks front-running the pack. Remember this was a period in which leverage was building and speculative juices flowing full steam.

In any event, it's pretty clear it was not a result of the Fed and QE.

5. QE has debased the dollar. Good luck convincing people this hasn't been the case. This is an excellent example of repeating a falsehood until it becomes accepted as true.

Again, roll tape…

This is the trade-weighted broad-dollar average. It, much like the oil chart above, shows all the action took place before QE and the crisis. From 2002 to 2007, the Big Dollar, as currency specialists like to call it, depreciated some 20%. And the fastest depreciation came…that's right, when the Fed was raising policy rates. Since the crisis oil has been roughly unchanged, with gyrations suspiciously similar to those of oil.

Bottom line: Anyone alleging debasement is working from hearsay and priors, not the scorecard. And there are some pretty high-profile people still throwing around the 'debasement' word.

In fairness, the Fed did assume that their exceptional monetary accommodation might result in some depreciation of the dollar. But because the US is a closed economy (exports and imports make up a relatively small share of GDP) the Fed felt-correctly in my view-that it should be setting monetary conditions based on the larger domestic economy. And if dollar depreciation were to ensue, so the thinking went, it would at the margin be positive for US growth, as long as the depreciation was orderly.

Why, then, did the dollar depreciate so much in the 2002-2007 period? For pretty much the same reasons that the price of oil went higher: It was a period of risk-taking, leverage, and deepening optimism regarding emerging markets. All three factors led to dollar selling -- and that was well before QE ever made its first appearance in the US.

In sum, much of the received wisdom surrounding the Fed and the effects of its actions is misplaced. Through repetition and ex-ante biases, deep misunderstandings have become engrained in market psychology.

Importantly however, the recent rise in the dollar and fall in commodities suggest that these long-held misguided views are becoming dislodged. There is plenty of risk ahead and the Fed's task is far from easy or over. But the Fed, for the most part, is ahead of the curve. Make sure you and your views don't get caught behind it.

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