Why Fed Narratives Can Be Dangerous For Your Portfolio

Over the course of my career I’ve endured endless Federal Reserve conspiracy theories. I’ve known people who stayed away from the stock market for the entirety of the last 20 years because they think the Fed caused the Nasdaq bubble, then inflated the housing bubble and then inflated the stock market with QE. But here’s the problem with that – this is mostly politics masquerading as pseudoscience.

I’ve done a tremendous amount of work describing how the Federal Reserve works. The main goal of that work is to separate the ideology from the empirical evidence. I think of the world much like an engineer might look at how a plane flies. First principles rule everything around me.

Now, when it comes to the Fed you have to be really careful because these can be the most dangerous narratives since they’re so politically charged. People despise the Federal Reserve because it’s viewed as this big money printing manipulation machine. But at its core the Fed is just a big clearinghouse that helps interbank payments settle. They exist because private banks are bad at clearing payments during crises so we used to get recessions that would then turn into depressions (like 1907 or the entire 1800’s) just because bankers turn into scaredy pants wimps during financial panics. 2008 was evidence that the Fed is fantastic at this primary role. They kept the payment system working when banks were on the verge of cratering.

This payment clearing role is never talked about in the mainstream media because it gets overshadowed by things like interest rate maintenance and QE. These narratives usually involve the idea that the Fed is “manipulating” interest rates and “printing money” via QE. I’ve done my fair share of griping at the Fed over the years and I certainly don’t like a lot of what they do, but these narratives are usually overblown for reasons I’ve discussed before: 1. The Fed controls the overnight rate on reserves, but doesn’t really control most interest rates; and 2) QE isn’t really money printing in any useful sense.