In theory, an economy based on the free market system thrives on supply and demand. The market is to set its prices and operate without any outside interference. External dynamics render a free market system hapless. The dynamics of an economic system are formulated by two imposing forces: the psychologies of the investor and the consumer. For example, in the failure of the two mega investment banks, Bear Sterns and Lehman Brothers, they survived as long as their investors stayed with them, but when the investor psychology changed because of fear, they pulled away causing the companies to crash.

Looking at the stock market’s increased demand, its growth is the result of the Fed’s monetary policy that manipulated interest rates to forge the advantage in existing investment opportunities to favor the stock market. Therefore, investors with cash in hand from the proceeds of the sales of some existing Treasury securities, took their money to the stock market, generating growth for the market.

The normal way the stock market should have grown is for the companies in the stock exchange to experience growth of profits that gives shareholders dividend payments and/or retained earnings (growth in the companies’ value per share of their stock) for shareholder growth in wealth.

Therefore, I see this increased demand in both sectors, stock market and housing (construction included), to be artificially generated by the Fed, not by the market place. In which case, we are not be experiencing a sustainable Recovery in the economy.

Artificial solutions in a system as complex as our economy serve as invitations to disaster. Later, we will look at the disastrous threat of inflation. There are too many “moving parts” in any system with this degree of complexity until failure dynamics can be disguised quite easily. Our economy is “sailing in uncharted waters” because of our unprecedented debt level and the global efforts to “dump” the dollar as the world’s reserve currency. Additionally, due to Quantitative Easing (QE1, QE2, and QE3) we have increased our money supply by some 400%. This makes America extremely vulnerable to inflation.

For the remainder of this Column, let’s look at the explanation of the “Primary Dealer Banks” mentioned earlier as the large banks that help the Fed market the U.S. Treasury securities (bills, notes, and bonds). In our case at hand, these banks assisted the New York Fed in buying securities on the open market for the QE program.

Primary dealers serve as trading counterparties of the New York Fed in its implementation of monetary policy. This role includes the obligations to: (1). participate consistently in open market operations to facilitate the direction of the Federal Open Market Committee (FMOC); and (2). provide the New York Fed’s trading desk with market information and analysis to assist in the formulation and implementation of monetary policy. They are also required to participate in all auctions of U.S. government debt and to make reasonable markets for the New York Fed when it transacts on behalf of its foreign official account holders. To become a Primary Dealer bank, they must pass stringent requirements in legal, operational, and technical areas of capabilities. Subsequent Columns will deal with the Federal Reserve System, the so-called money printing, and America’s debt. Take heed of 2 Chronicles 7:14.

By Aaron Russell, Sr.