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Federal Funds Rate: You’re Afraid of the Big Bad Wolf

Posted by kdadmin on July 15th, 2015.

Federal Funds Rate: You’re Afraid of the Big Bad Wolf

As a child of ten, the Little Red Riding Hood story always annoyed me. My takeaway was that wolves were stupid creatures. Now, if you were a wolf, who lived in the forest, and you had huge fangs and gnarly claws, why would you wait to ambush a helpless child in a house where a hunter could kill you? Why wouldn’t you just eat her at your leisure in the forest? I mean, duh, Mr. Wolf.

Maybe I missed the point …

Which was, as repeatedly explained to me, that the story was a metaphor for the fact that I was, in fact, the small child. And that, apparently, I had to be rescued by adults, in this case some weirdo in a beard, because I was dumb enough to walk through a forest, where wolves lived, by myself, at night, and couldn’t tell the difference between a wolf and my grandmother. Sorry. No sale. I’m not a moron.

This became a battle in my childhood home …

Eventually, after being told that I should like such a stupid story, and shamed about loathing it, I took it upon myself to illustrate my point. Back then, my dad often came home late in the evening. So over a period of a couple of weeks, I made it a point to stay up late, quietly, in my room, until I heard the garage door open. Then, I would go and hide somewhere in the house, and wait to ambush him. Over and over, I would scare the living daylights out of him as he wandered the house at night. He would always be too shaken to punish me, and I would skip off to bed.

After about two weeks of this, we had “a family meeting” about my behavior. My parents read me the riot act about this and that and blah, blah, blah. At the end, they demanded to know what I had to say for myself. I simply said, “The wolf was an idiot. Look how easy it was for me to sneak up on Dad. If I had been a wolf, and he had been Little Red Riding Hood wandering through the forest at night, I could have easily eaten him. I hate that stupid story.”

I got in HUGE trouble.

HOW. EVER. It was worth it. I made my point. And I never had to hear that dumb story about how some “authority” was going to rescue me from a Wolf that I could easily avoid.

I tell you this for two reasons. One to thank Edvard Grieg for building this picture perfect Grandma’s House just outside of Bergen, Norway. And two, because of the following chart. When it comes to economic manipulation, the Federal Reserve is the Big Bad Wolf of monetary policy. Just look at the most recent two times that the Federal Reserve got aggressive with the Federal Funds rate. How did the economy fair? Not good.

Little Red Riding Hood

First, was the increase in Federal Funds rate from 1993 to 1998, when Federal Reserve was trying to slow economic growth. They backed off a bit in 1997, but when the Dotcom bubble hit (1998-2000), they cranked the rate up to over 6.4%, and POW the market blew up. Quickly, their rate plummeted with the market in an effort to “stimulate growth.” Second, as the market started to pick up in late 2003, the Federal Reserve over compensated from 2004 to 2007, cranking rates up from about 1% to over 5%. Until, POW the market blew up in the sub prime melt down. And here we are back at 0.25%

While obviously not the whole of the economic story, what does this tell you?

How about that using the Federal Funds rate to control the economy is not an exact science? How about that the Federal Reserve hasn’t been that great at it in the past? How about that relying on the Big Bad Wolf of financial market manipulation may NOT be your best course of action?

Look, at the end of the day, we can’t rely on a (quasi) government agency to save us from an overvalued market and overpriced stocks. This is NOT how the market works. It’s very hard to catch a falling knife. Instead, we can study history. We can look for patterns in behavior. We can look at the current macroeconomic indicators. And, we can come to our own conclusions. Like, for instance, that we are wise to be wary of the market when Federal Reserve intends to make a significant change to the Federal Funds Rate.

At a certain point, we have to be smart enough NOT participate in such a market. We have to be smart enough NOT to walk through the forest alone, at night, when the wolves are present.

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