Lewis Is Right: The Market Is Rigged, To The Upside

On Sunday night, author Michael Lewis shocked the world on the 60 Minutes television program, by announcing that the market is “rigged”.

Lewis' premise, that High Frequency Trading has created an unlevel playing field for investors, has some merit. However, only Predatory High Frequency Trading tactics have a negative impact on the market. Several of their tactics provide liquidity for the market -- and actually create trading opportunities for savvy traders.

But I do have to agree the market is “rigged,” and it is rigged to the upside for one basic reason.

From a macro-economic standpoint, the Federal Reserve Bank and its Quantitative Easing policy has successfully applied band-aids to an economy that needs major surgery.

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The notion of QE is an outrageous policy in the first place. It is an unconventional monetary policy used by central banks to stimulate an economy when standard monetary policy has become ineffective.

As a result of the central bank buying specified amounts of financial assets from commercial banks and other private institutions, the monetary base is increased by lowering the yield on those financial assets.

In other words, QE stimulates the economy by purchasing assets of longer maturity rather than short-term government bonds, and lowers longer-term interest rates further out on the yield curve.

Simply put, the Fed is printing money and pumping it into the economy -- keeping interest rates artificially low. And with all money being flushed into the economy, it has to find a place to go. With bonds and treasury yields not keeping up with inflation, this money has nowhere to go, except for the stock market.

All of this taking place while the public is under-invested, after being forced out during the 2008-2009 financial crisis, and unsure when to get back in. Therefore, all the “free” money being pumped into the economy is competing with the money managers as well as the public, for assets that provide passive income.

Essentially, the Fed has forced the hand of many investors and left them no choice but to invest in the stock market. Active investors may choose to start a new business, as opposed to taking unwanted risk in the market, but passive investors are left with very little alternatives other than investing in a potentially inflated stock market.

By continuing with QE2 and QE3, the Fed has only exacerbated this phenomena. And with the economy only growing at a modest rate despite these efforts, the Fed has backed itself into a corner. QE forever.

That's right, any time the unemployment rate or economic indicators signal any weakness, the Fed can reverse the tapering process and turn on the spigot, pumping more and more money into the the economy to maintain anemic growth.

All of this is fine and dandy if inflation remains low. And with the Fed already depressing the rate of the Core Producer Price Index by excluding food and commodity prices, the true rate of inflation may not be known. Since consumers spend a large portion of their income on energy and food, excluding these elements may a create a distorted view of inflation.

For now QE has helped ensure that inflation does not fall below projected targets. However there is a significant risk that this policy may be more effective than intended in acting against deflation, which may lead to higher inflation in the longer term, due to the increased money supply.

If that comes to fruition, the Fed will have no choice but to raise rates and the whole market will come crashing down.

As long as the Fed can mask the true rate of inflation and continue with QE forever, the market will remain “rigged” to the upside. Enjoy the ride and do not hesitate to take some profits along the way.

With the amount of money being printed and pumped into this economy, it is unreasonable to believe that inflation can remain low forever.