by Dr. Mark Skousen, Advisory Panelist
In 1961, the great free-market economist Milton Friedman wrote a paper called “The Lag in Effect of Monetary Policy,” wherein he discovered a six- to nine-month delay in how long it would take for a change in monetary policy to be felt in the economy and the stock market.
Since then, it has been known as “The Friedman Effect.”
It’s important to understand the Friedman Effect because it can have dramatic impact on your investment decisions and your portfolio…
Milton Friedman & The Friedman Effect
Basically, Milton Friedman found that if the Fed switched from tight money to easy money, or vice versa, it would take about six months before you would see any change in the direction of the economy or Wall Street.
The Friedman Effect worked like clockwork during the financial crisis of 2008. In late 2007 and early 2008, the Fed decided to squeeze the money supply and impose a credit crunch on the financial markets to slow down the real estate boom. The Fed got more than it bargained for. Its tight-money policy had a dramatic impact - the real estate market crashed and took the financial markets with it.
The Fed panicked and in September, 2008, Ben Bernanke & Co. reversed course and injected billions of dollars into the marketplace. The Fed’s balance sheet (see chart below) doubled in a few months as the Fed acted aggressively. Among other bold efforts, the Fed bought Treasuries and mortgage-backed securities directly in an effort to stem the tide of a deflationary collapse.
As you can see from the above chart, the Fed’s bank account (Adjusted Monetary Base) doubled in short order in 2008-09.
The Friedman Effect - Pinpointing The First Signs of Recovery
According to the Friedman Effect, that means the first signs of a recovery and stock market rally would occur six months later. Sure enough, in March, 2009, Wall Street bottomed out and roared ahead in one of the strongest rallies in Wall Street history. The S&P 500 Index has climbed an incredible 34% from its lows of March 8.
Moreover, we’ve seen sure signs of stabilization in the financial markets and the economy.
