I have refrained from publicly criticizing FOMC policy until now. My criticisms have been private, exclusive to the subscribers of my newsletter and my managed account clients, but at this point I feel it is appropriate to disclose these criticisms publicly. The following details my opinion of the flawed FOMC policy that will eventually cause wealth destruction in the U.S.

First, I have already publicly praised the operations of the FOMC after the credit crisis hit because the initial stimulus operations stabilized the financial system, and had it not been for that prompt action the economy absolutely could have fallen into a much Greater Depression. Therefore, the intentions of the FOMC on the heels of the credit crisis were completely appropriate.

Then something changed.

Specifically, as the market and the economy began to flounder in 2012 the FOMC decided to engage a policy whose directive wasn't to stabilize the financial system but to instead induce the wealth effect and spur the economy by inflating asset prices. If you don't believe that this was the objective of the FOMC when they engaged in the monthly stimulus program at the beginning of 2013, think again. The decision was to buy assets in the open market so that those financial institutions who own those assets could make new decisions with that money, in some way shape or form.

The net result creates added velocity in the monetary system and ultimately, the hope is that the added velocity of money would somehow add inflationary pressure to the economy. The worst thing for an economy is deflation, and although no one really trusts an inflation driven economy, small levels of inflation are ideal. This was the goal of the FOMC as it engaged in renewed stimulus programs as we entered calendar 2013. As they pursued this program, inflation pressures didn't mount, and arguably inflation is still not a problem, even after the trillions of dollars of infusion.

That is, unless you're looking at the stock market and housing.

One of the natural byproducts of stimulus is fabricated demand. Yes, increasing the velocity of money is one, but when the financial system is flooded with excess liquidity the demand for investments also increases, and it is that demand that influences the wealth effect. By definition, when people perceive themselves to be wealthier they are more willing to spend money and further influence the velocity of money in the financial system at a grass-roots level.

Therefore, even the natural byproduct of stimulus serves to influence the velocity of money, but that natural byproduct also does something that ultimately serves as the catalyst for my criticism.

Specifically, by influencing asset prices higher stimulus efforts run the risk of causing asset prices to exceed their fair value. In my recent analysis of the components of the Dow Jones Industrial Average DJIA, -0.87% I identified a number of large cap companies that exceed their fair value. Those include companies like Merck MRK, +0.19% Procter & Gamble PG, -0.10% and Chevron CVX, -0.73% , just to name a few. My analysis suggests that because there was more liquidity in the financial system chasing the same assets, in this case the Dow industrials, some stocks were bid up even though their earnings growth rate didn't warrant it.

This is where the distortion in fair value comes from.

Fair value is based on a comparison of price and earnings growth, but when excess liquidity floods the financial system and asset prices increase simply because there is more money available to be buying those assets and not because of earnings growth asset bubbles are created.

Unintentional as it may have been, the policy of the FOMC to influence the velocity of money and the wealth effect served to increase the demand for assets and push asset prices beyond their fair value.

Of course, that raises the question what is fair value, and although I believe my macroeconomic analysis, The Investment Rate, paints the best picture of fair value, I also created a detailed fair value analysis of each one of the Dow companies to be more current and specific. When we combine these observations, it helps us understand what the fair value of the Dow is too. You can read all of these valuation analyses in the news section of my website.

Conclusion and criticism

When the FOMC changed the directive of its stimulus policy to influence the wealth effect it engaged in a policy that not only ran the risk of creating an asset bubble at the time, but one that actually did create an asset bubble now that it is over. And that is what defines the economy we are in today.

Thus far, every other asset bubble in modern history has ended badly, and this one will, as well, in my opinion. If it does, Bernanke will be criticized as much as Greenspan was on the heels of the credit crisis, and everyone who was praising Bernanke for his ability to spur the economy will ask why he couldn't have seen this coming. I don't envy him, but I am now making my criticism public.

The FOMC caused this asset bubble.