John Hussman: Investors Are Counting Too Much on the Fed

Too many investors are convinced that when the economy sours, the Federal Reserve will intervene with monetary stimulus measures and save the day by pumping up stock prices, economist and fund manager John Hussman said.

Monetary tools like interest-rate cuts or liquidity injections aim to jolt the economy and steer it away from decline but don't make fundamental improvements to the country that are needed for lasting growth, such as fiscal reform.

"So what do I worry about? I worry that investors forget how devastating a deep investment loss can be on a portfolio," Hussman wrote in a letter to investors. "I worry that the constant hope for central bank action has given investors a false sense of security that recessions and deep market downturns can be made obsolete."

Editor's Note: Sept. 18 Cover-Up Is a Final Turning for America

"I worry that the depth of the recessions and downturns — when they occur — will be much deeper precisely because of the speculation, moral hazard, and misallocation of resources that monetary authorities have encouraged. I worry that both a global recession and severe market downturn are closer at hand than investors assume, partly despite, and partly because, they have so fully embraced the illusory salvation of monetary intervention."

The Federal Reserve will meet this week to address interest rates. And talk is building the U.S. central bank will intervene to stimulate the economy to steer the country away from deflationary decline while encouraging investing and hiring at the same time.

The Fed has jolted the U.S. economy with two rounds of quantitative easing (QE1 and QE2), under which the Fed buys bonds from banks, injecting them with liquidity to spur recovery, and talk has continued to build that a third round (QE3) is on the way in wake of sagging economic indicators.

Other tools up for consideration involve the Fed cutting the 0.25 percent interest rate the Fed pays on bank reserves, which would incentivize financial institutions to lend more and less to keep money stashed in Fed accounts.

Other experts have pointed out that the Fed has done all it can, as interest rates are already low enough.

"The Federal Reserve has already pulled all the levers that might make a difference. Short-term interest rates — such as the overnight bank borrowing rate and one-month and one-year Treasury Bill rates — are already close to zero," Peter Morici, a professor at the University of Maryland's Smith School of Business, wrote in a CNBC guest blog.

"Central bank policy can help dampen inflation when the economy overheats and lift borrowing and home sales a bit when it falters, but it can’t instigate faster growth when the President and Congress fail to address structural problems," Morici added.

Editor's Note: Sept. 18 Cover-Up Is a Final Turning for America