The Federal Reserve just released the minutes of its October 23 and 24 meeting of the Open Market Committee. Two of the headlines:
More easing than from QE3? Apparently! These minutes seem to indicate how desperate some members of the Fed's Open Market Committee are. I know, officials in the Federal Reserve System have the burden of all of history on their shoulders.
What if the economy doesn't pick up steam? What if unemployment remains around 8.0 percent? What if the United States goes into another recession, one following right on the heels of the Great Recession?
Many economists and historians place the primary blame for the Great Depression on the action … or lack of action … of the Federal Reserve System. That is a heavy weight to carry around.
The suggestion offered by these economists and historians on the failures of the central bank in the 1930s: the Fed should have erred on the side of too much ease in its monetary policy. That seems to be exactly the medicine that the current Fed is applying to the economy.
Let's ease up and then if that doesn't work then we will just ease up some more. And, if that doesn't work we will apply more monetary ease and if that doesn't work we will apply even more.
Mohamed El-Erian writes in the first article cited above:
"While the Fed is already deep in experimental mode, the minutes confirm that officials there are already considering additional measures. There are two reasons for this. First, their baseline economic expectations remain subdued as more positive housing and consumption indicators are offset by slower business activity. Second, they recognize the "significant downside risk" to the baseline forecast due to the global economy's synchronized slowdown and the possibility of further financial shocks, such as the US falling off the fiscal cliff."
And the beat goes on!
Right now, the Fed is underwriting the debt of the U.S. government and allowing its budget deficit to no more than something a little over one trillion dollars per year. This makes it easier for the president and Congress to postpone fiscal decisions for as long as they can. And, besides the Federal Reserve, the U.S. government has foreign investors more than willing to buy U.S. Treasury securities. Right now, foreign investors hold more than 45 percent of all tradable U.S. securities.
What are some of the potential consequences of this situation? Well, if interest rates were to begin to rise, would these foreign investors continue to hold onto the securities … or would they begin to dump them?
Presently, the Fed officials are saying that they will maintain the low level of interest rates into 2015. So, these foreign investors can maintain some degree of confidence that the interest rates don't rise and they also have the confidence that the U.S. will not default on their securities and that is why they have migrated to such "quality" issues.
Furthermore, there is the argument that the Fed cannot allow interest to rise because of the impact that rising interest rates would have on the federal deficit. Robert Jenkins is a former fund manager and current external member of the Financial Policy Committee of the Bank of England writes:
"U.S. debt outstanding exceeds $16 trillion. Each percentage point rise in interest rates adds (over time) $160bn to annual debt financing. Thus a 5 per cent rate rise adds $800bn to the budget deficit and, given compounding, more than $8tn per decade to the national debt."
In addition, what if the quantitative easing creates a bubble in the housing market … or elsewhere. The U.S. housing market seems to be recovering, even at a low level of activity, but housing prices are beginning to rise at a fairly rapid rate. Some analysts are concerned that with all the money floating around in the mortgage arena there will be more movement in home prices than in actual construction. Of course, this may not be all bad because it would "but out" a lot of homeowners that are facing underwater mortgages.
The concern from the economic side is that in this stage of the business cycle, further efforts to inflate the economy may have little or no "real" effect. That is, additional monetary stimulus will do little to increase economic growth or lower unemployment. This conclusion was once taught in monetary economics. And, for more than two years all the monetary stimulus that has been thrown at the economy has had little "real" effect.
So, we go back to the mental state of the officials in the Federal Reserve System. More monetary stimulus may be on the way. However, the major impact this monetary stimulus may have is on the egos of the monetary authorities. They want to be in a position where they cannot be accused by future economists and historians of not being easy enough.