Reply #2: WHEN THE BIG BOYS BUY

[ozymandius]

by Doug Wakefield

Imagine owning a stock that you find out Warren Buffet is about to buy or learning that the property next to your raw land had just been purchased for a billion dollar development. You’d be more than a little excited and rightly so. We know that the investment actions of large investors, who going forward, I’ll call the big boys, have a major impact on our much smaller investments. In this article we will look at the ultimate big boy, who not only has the power to make huge purchase, but also can print the money needed to do so.

Let’s start with the Federal Reserve Bank of New York’s description of open market operations, one of the powers of the Federal Reserve. The Fed can “buy or sell U.S. Government Securities in the open, or secondary, market as one of its most flexible means of carrying out its objectives.”1

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While it goes without saying that the Federal Reserve is a “big boy”, the record regarding their sizable buys and sells of U.S. government bonds, makes it increasingly clear that the Federal Reserve is not a heady bunch of uninterested, laissez faire economist relegated to studying reams of economic statistics. They are also a major player who continuously exerts a substantial influence on our bond markets, and therefore our markets as a whole.

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In his speech given on in November 2002 entitled, “Deflation: Making Sure “It” Doesn’t Happen Here”, Dr. Bernanke reiterates the Feds tendency toward open market operations. “Under normal conditions, the Fed and most other central banks implement policy by setting a target for a short-term interest rate and enforcing that target by buying and selling securities in open capital markets.” This comment fits with everything that we have discussed so far, however the next one is somewhat alarming. “Like gold, U.S. dollars have value only to the extent that they are strictly limited in supply. But the U.S. government has a technology, called a printing press, that allows it to produce as many U.S. dollars as it wishes at essentially no cost. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.” 5

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http://www.financialsense.com/fsu/editorials/2005/0621.html