Problem: It's not working anymore

The main beneficiaries of all the cheap money sloshing around have been financial markets, banks and politicians. According to Bank of America Merrill Lynch, global financial stress has fallen to a post-recession low over the past few weeks as stocks have posted their best, low-volatility rally in decades. Financial stocks like Goldman Sachs (GS) have been marching higher on a perfect, unblemished 45-degree uptrend.

Yes, average folks have seen some benefit, too. Americans' saw their wealth in 401k and other investments grow as the Standard and Poor's 500 Index ($INX) rose to 3.8% over its September 2012 high. That's good but not great.

And definitely not worth the problems I believe this is causing.

By keeping Treasury bond yields in negative inflation-adjusted territory, the Fed has reduced borrowing costs. That has eased the pressure on Washington to address its unsustainable fiscal path -- just as low rates have allowed Tokyo to gorge on debt, accumulating a government-debt-to-GDP ratio approaching 230%, which is more than twice the rich-world average.

And as the risks are rising, the positive wealth effects are diminishing, according to research by Credit Suisse economists. What they found is that central bankers and their allies are taking more risk, with potentially disastrous consequences for the global financial system, in exchange for less and less wealth benefit.

They also found that since the 2007-2008 financial crisis, the positive economic effects of higher prices for assets like stocks and houses have shrunk. Sensitivity to housing wealth -- or how likely it is that an increase in housing wealth will encourage new consumer spending -- has fallen roughly 35%, while sensitivity to stock market wealth has fallen 27%.

The result helps explain why consumer spending growth has been so modest in this recovery even though the S&P 500 is up 139% from its 2009 low. 

The drag is likely being driven by a few things. One is that nearly one-third of mortgages are still "underwater" -- so any price gains now will be viewed only as cutting losses. It's not like back in the 2006 go-go days, when people used the equity in their homes as ATMs.

As for stocks, the S&P 500 has merely returned to its 2007 highs -- levels first reached back in 2000. That doesn't feel like a gain.

Plus, the quirks of human emotion doomed the Fed's efforts from the start. People are much more sensitive to falling home prices and falling stock prices than they are to gains. In other words, declines in wealth have a bigger impact on consumption than increases do. Plus, the wounds from recent losses are still raw.

On the flip side, the work of James Hamilton, an economics professor at the University of California, San Diego, suggests that people are more sensitive to oil prices on the way up than on the way down. And we all know that gas stations raise prices a lot faster than they lower them.

In short, gas going over $4 hurts more than Dow 14,000 feels good.

The path not taken

So after they quelled the panic in 2008 and 2009, central bankers should've stepped back, swallowed their pride, and admitted they had done all they could. We don't have a lack of liquidity. Taking the U.S. monetary base, the most basic measure of the money supply, from $800 billion before the financial crisis to more than $3 trillion now was overkill.

If you take one thing away from this, Federal Reserve historian and Carnegie Mellon economist Allan Meltzer suggests you consider the chart below. It compares consumer sentiment (the blue line) to the massive accumulation of the Fed's cheap money in bank vaults in the form of excess reserves (red line). Before all this started, the banks didn't have a need for extra money sitting idle. Thus, excess reserves were consistently low.

University of Michigan

After the past few years, as the Fed and other central banks pump and pump, banks are essentially drowning in the money. They can't find enough high-quality loan opportunities, and loan demand has been tepid, so they are essentially shoving the money under their mattresses, so to speak, by increasing their excess reserves.

And yet, all this enthusiastic money printing and its effect on the stock market have barely budged consumer sentiment. And consumer spending fuels our economy.

Based on those Wal-Mart emails, and considering the other head winds we face in the weeks to come, I expect the blue line to fall away again as consumers retrench and cut spending.

All because Federal Reserve Chairman Ben Bernanke and the handful of souls who control the Fed (and their foreign counterparts) have decided that Dow 14,000 is more important than keeping gas below $4 a gallon.