Has the Federal Reserve's Ben Bernanke created a stock market monster?

As Canada's central bank governor, Stephen Poloz, prepares for his first interest rate decision on Wednesday, Bernanke is trying again to clarify his position to the U.S. Congress. After the fortunes made and lost the last time he spoke, everyone is waiting with bated breath.

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Ben Bernanke of the Federal Reserve: Markets are hanging on his words. (Associated Press)

If you don't watch the markets too closely, you might be surprised by the perverse effect his words have had in the past.

When Bernanke, the head of the world's most influential central bank, told us at the end of June that the U.S. economy was showing signs of recovery, markets plunged. Last Thursday, when Bernanke turned glum, warning that unemployment rates continue to look terrible, stocks hit a new record high.

Wall Street reaction disturbing

Sympathetic as I am to people investing for their future, Wall Street's chorus of boos in June for news of an improving economy, and the roar of cheers last Thursday for the weak outlook for jobs, was disturbing.

'What kind of distorted system have we created when the stock market has become a hedging mechanism against a country’s general economic well-being?'—Don Pittis

When the economy is getting stronger, you imagine companies would be raking in piles of cash as they sell their goods to increasingly well-off citizens. That should make their stocks go up.

But that is exactly the opposite of what has been happening.

The technical answer for this apparent Bizarro World is that the normal rules of the conventional market — rewarding success and disciplining failure – have been temporarily suspended, or at least overwhelmed, by a greater force. Namely, the decisions of central bankers on how to set their interest rates.

Central bankers like Bernanke, Poloz at the Bank of Canada and Mark Carney, who just started at the Bank of England, have been holding interest rates far below market levels.

Central bankers' roles

I have previously discussed some of the difficulties central bankers face when they decide they have to raise interest rates, so I won't repeat them all here.

But the nub of it is that in an attempt to wake up their tired economies with a shot of adrenaline, central bankers are keeping interest rates unnaturally low and money unnaturally cheap. In the U.S., Bernanke is actually creating imaginary money through the process called quantitative easing – or money printing – to buy up bonds, supposedly to give the economy an extra jolt.

But here is the difficult question: What kind of distorted system have we created when the stock market has become a hedging mechanism against a country’s general economic well-being? It’s as if the markets had been created as a derivative constructed to make money from a weakening economy. And make no mistake, there are huge fortunes – almost every penny invested in stocks – gambled on this derivative. And that kind of money has power.

Anti-economy hedge

Evidently, every time Bernanke suggests that this hedge should be reversed, that money printing will stop and the economy will improve, there are screams of outrage from rich and powerful people.

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Stephen Poloz makes his first interest rate decision for Canada tomorrow. (Canadian Press)

Everyone knows the central bankers are using strong medicine. If they and their rooms of experts are convinced the medicine is working, and that extending the distortions in the normal workings of the markets for the sake of the economy is reasonable, there may still be justification for continuing the prescription.

But at some point, it is essential that the anti-economy hedge of the stock market must be reversed, so that markets can work the way they are supposed to.

In the meantime, Bernanke must make it absolutely clear that he is not being overly influenced by the cheers and boos of Wall Street. One of the worst things about the collective mind of Wall Street is that it thinks short term. Central bankers must not.