The Feel Good Fed by ITR
Wednesday, September 26, 2012

Section: Press Releases

On September 13th, Federal Reserve Board (FRB) Chairman Dr. Ben Bernanke announced a third bond-buying program (Quantitative Easing Three) at a cost of $40 billion a month. He also extended Operation Twist through December, attempting to infuse $85 billion a month into the economy. Interest rates will be low into 2015. Some might wonder if QE3 is a band aid that will fall off to expose a more severe infection later.

In effect, the FRB has shifted from its "dual mandate” (price stability and maximum employment) to focus on employment. The infusion of liquidity will likely fuel inflation over the long term, but the Fed is willing to take that risk now. By extending the monetary policy timeline indefinitely, the aim is to create certainty and a "wealth effect” that will trickle out to the economy. The message is to stop hoarding cash, borrow more, and spend freely to juice demand in the US economy. Not a sure bet.

At Jackson Hole, Dr. Bernanke claimed that FRB policies have created two million jobs. Add QE1 ($1.25T), and QE2 ($600B) and you get $1.85T. That is approximately $925,000 per job created, a tad high for job creation and reminiscent of other stimulus promises. QE3 is expected to cost $480 billion annually. Dr. Bernanke admitted that the FRB’s decision is "not a panacea” and will not avert a "fiscal cliff” if policy makers don’t do their part. We agree that QE3 will have minimal impact near term but has the potential to worsen matters in the long run. This does not alter our 2014 recessionary call.

Who benefits most from this? Investors: equity markets soared and the bond market avoids a bubble burst. Big bonuses on Wall Street this Christmas. Commodity and currency traders and exporters will benefit from a weaker dollar. High-quality borrowers have access to even more cash – longer. Everyone who has a 401k and owns a home may feel a bit wealthier for now. Those with high credit scores have more time to purchase a home at historic low rates. Perhaps Congress can breathe easier ("fiddle while Rome burns”) as the FRB makes debt/deficits appear less threatening.

Who doesn’t benefit from this? Anyone buying US debt will end up losing. Additionally, seniors who are risk-adverse at this stage in life and want to save what they have will not see a return to income levels they desire. Those who have poor credit and face foreclosure will still find banks stingy. The unskilled unemployed won’t find job hunting easier. The middle-class may someday rue this decision, when future inflationary pressures (gas/food) devour their earnings at a quicker pace. In short, many who need help now will continue to struggle. In fairness, the FRB can’t solve all these issues.

Implicit in the FRB announcement is that trillions in stimulus has not yet produced self-sustaining growth in the US economy, that employment growth is not keeping up with the birth rate, and that wages are not keeping up with real inflation. This is not an encouraging "go-get-‘em” message. The FRB is focused on desperate near-term stimulus and results.

Based on anecdotal conversations with leaders across hundreds of different industry sectors, what they want is more than an attempt at boosting aggregate demand for the short term. Business leaders want clarity on health care costs and taxes in 2013-2014, a leadership that stops borrowing as if there is no tomorrow, and a vision of the future longer than a two-year election cycle. The decision by the FRB may provide a minimal short-term boost, but it leads us more clearly down the path of exchanging the end of the Great Recession/recovery for the onset of a Great Depression down the road.

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