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The Federal Reserve: Leader or Follower? Print E-mail
General Investing Articles | Written by Robert Prechter |

The Federal Reserve: Leader or Follower?

By Elliott Wave International's Robert Prechter, Prechter's Market Perspective
Nov 11, 2005

Ben Bernanke's confirmation hearings are on tap on Capitol Hill. With near certainty that he will be confirmed to replace Alan Greenspan as the Federal Reserve chairman, our minds turn to what powers the Fed really has. Here's an excerpt from Bob Prechter's question-and-answer book, called Prechter's Perspective, that describes how the Fed actually follows the markets rather than leading them.

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The unprecedented popularity of Alan Greenspan suggests that most people believe in the power of the Fed to prevent a crash.

Bob Prechter: The Fed's apparent success in 1987 made people, including Fed governors, confident that they can stop the next crash. But it won't work (more than briefly, anyway), because the wave of selling will be much bigger. When the Fed itself, then the professionals and soon afterward the public, realize that the Fed's attempt is failing, the overall panic will increase, at minimum negating any bullish effects of whatever actions it takes.

But there are no restrictions on the Fed, and, in recent years, especially in 'crisis situations,' we have seen there is no hesitancy to do whatever it takes to bail out troubled entities. Won't the Fed just lend its way out of the problem?

Bob Prechter: While it is true that the Fed has an unlimited power to offer credit, it cannot create liquidity, because it cannot force businesses and consumers to lend and borrow no matter how cheaply it offers credit. So deflation can happen regardless of the Fed's desires.

The Fed has always been a focal point for the financial markets. In recent years, people's attention is absolutely riveted on every Fed meeting. Is this attention misplaced?

Bob Prechter: The obsession with the Fed's meetings is ludicrous. The Fed votes only to change its own rates, and it has always followed the rates set by the free market. In 1999 and 2000, when the Fed raised rates several times, it was repeatedly claimed everywhere that the Fed was conducting a 'pre-emptive strike against inflation.' But rates had been rising for months, and the Fed simply adjusted to the market, as always. We watch the market, which leads the Fed.

In the wake of an unexpected central bank action, have you ever had a wave pattern that skipped a beat or altered its course in any way?

Bob Prechter: Central bank action is never really unexpected because it's a product of the social mood, which permeates society. When you examine the charts, you can locate waves, but you can't locate central bank actions. Central bankers hope and panic and make decisions the same way the public does. Bankers are people, too, after all. They say, 'We've got to react to this new condition. We've got to move money here. We've got to move money there.' They are racing back and forth in rhythm with the market.

Politicians are the same way?

Bob Prechter: Sure. They react to markets; they don't move them. You'll find that a lot of political acts occur at predictable times, usually near the bottom of C waves and the top of fifth waves.

Since politics is so far behind the curve, why even talk about it?

Bob Prechter: If you're a trader or investor, there is no reason to talk about it at all! If you want to anticipate political change, which is something altogether different, the best way is to watch the stock market, which is the premier measure of a society's psychology.

In the end, people get to take their frustrations out on the politicians. At least there's that.

Bob Prechter: In the modern age, we're very lucky. In ancient times, when bear markets occurred and sovereigns had a lot of power, they went and chopped people up. But in modern days, it's the people who chop up the politicians. Except in war. That's when politicians go back to their roots.

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