Truth Frequency Radio
Nov 17, 2013


It’s conventional wisdom  that quantitative easing by the Federal Reserve is propping up stock prices, a “sugar high” as  Mike Johanns, Warren Buffett’s senator, claimed as he questioned Janet Yellen yesterday.

Consider: Since the Fed began its second round of QE in November 2010, the Fed’s balance sheet has risen by 69% to $3.86 trillion. Meanwhile, the S&P500 index is up by 600 points, or 50%. The correlation between QE and stock prices is an impressive 0.94.

It surely follows that when the Fed begins to taper, the stock market will stall. And when the Fed begins to shrink its balance sheet, prices will plunge. Right?

Not so fast, says Ethan Harris, global economist for Bank of America Merrill Lynch, who calls the relationship between the Fed’s balance sheet and stock prices a “spurious correlation.” That’s what happens when you confuse a coincidence with cause and effect. “One of the big no-no’s  in statistics is to correlate two trending variables,” Harris writes in a weekly note to clients.

Harris notes that the Fed’s balance sheet has been growing for the past three years, and a lot of other things have also been growing over that time. It’s easy to draw pretty charts that reach ridiculous conclusions using spurious correlations.

The Fed’s balance sheet has a 0.95 correlation with the U.S. population, a 0.94 correlation with vehicle sales, a 0.92 correlation with liquor sales.

“Taken literally, the Fed is pushing people to drink, drive and have children,” Harris says.

–Rex Nutting

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