Dow Jones high on Fed steroids: Our view

USATODAY

Four years after the stock market hit bottom, it is flirting with an all-time high. On Monday, the Dow Jones industrial average enjoyed its second highest close ever and was just 37 points away from a new record — more than double its level during the dark days of March 2009.

The turnabout is testament to healthy corporate profits and the resilience of America's free enterprise system. And it's a huge relief to workers whose 401(k) plans are tied to equities. But the risky little secret of the rebound is that it is powered in significant part by the easy-money policies of the Federal Reserve, which must one day end.

To combat the Great Recession, the Fed has bought trillions of dollars of mortgage bonds and U.S. Treasuries to juice the housing market and the economy in general.

On balance these purchases — which go by the non-threatening name of "quantitative easing" — have been warranted, given the deep economic problems caused by the financial crisis. But the time is approaching to scale back the bond-buying spree and get ready to unwind some of the Fed's massive portfolio, which now tops $3 trillion. The longer the policy lasts, the more likely it will end unhappily.

The Federal Reserve's purchases have driven interest rates to near zero. This has stimulated the economy but not without cost. Savers, particularly older ones trying to live on income from their investments, are starved for safe options. They've been forced into stocks, which is one reason the market has been acting as if it's on steroids. Further, with borrowing costs low, Congress and the White House have less incentive to rein in the national debt. Rock-bottom interest rates have also distorted markets.

The best indication that the Fed's bond-buying purchases are pushing stocks up artificially is that investors run for cover whenever there is a hint that the Fed might change course, as happened recently. On Monday, billionaire superinvestor Berkshire Hathaway CEO Warren Buffett told CNBC that markets are on a "hair trigger" waiting for signs of change from the Fed. The market is "hooked on the drug" of easy money, Dallas Fed President Richard Fisher told Reuters.

Fisher's comparison of Fed policies to a drug is apt. Markets might not like the idea of the drug being withdrawn now, when the Fed holds a portfolio of $3 trillion. But the withdrawal symptoms will be a lot worse once the portfolio grows to $4 trillion, or more.

No one has a clear idea how the Fed plans to unload such staggering sums. As it sells off its hoard, the value of all bonds could plunge, more than wiping out the small returns bond investors are getting. But holding onto the bonds as the economy stabilizes would set off inflation, which the Fed is required to combat.

That's a good reason to start thinking about an endgame sooner rather than later. The longer the Fed's easy-money policies go on, the greater the risk they will distort markets, create new bubbles and set the economy up for another fall.

Fed Chairman Ben Bernanke has taken many bold and important actions, quantitative easing included, that averted a depression and propped up the economy during difficult times. He should be congratulated. But he's now left searching for a Goldilocks moment to reverse course, and such things are hard to divine.