Thursday’s news by the FOMC caught many traders off guard. Of course most of us expected rates to remain targeted at basically zero (the official range is 0 to 0.25%), but the additional measures were unanticipated. According to the announcement released at 2:15 EST, the Fed will purchase $300 Billion worth of long-dated treasuries over the next few months, and roughly $750 billion worth of agency notes (primarily Mortgage Backed Securities).
The news sent markets into high gear with gold rebounding from its recent pullback and the dollar falling sharply against the Euro. Equity markets celebrated the news with the S&P up 20 points initially before settling back a bit before the close. Those who used to taunt Bernanke by calling him “Helicopter Ben” are now revising the phrase to “B-52 Ben.”
Since the Fed is designed to operate autonomously (without the day-to-day influence of Congress or the Executive branch), the measures can be enacted immediately without bureaucracy getting in the way. This is good news at a time where quick decisive action is needed. However, the flip side of this coin is that if the American people do not agree with the policies of the FOMC, there is little recourse available in the form of short-term checks and balances.
Back to “B-52 Ben…” The measure approved by the FOMC Wednesday essentially opens up the printing presses and floods the markets with new capital. This isn’t a new tactic as we have mentioned the danger to our currency many times in the recent past. But this particular measure is being called a “measure of last resort” by some. While the Wall Street Journal called it a “bold statement of force,” questions have been raised about the responsibility of this measure and what will happen if it fails.
Circular Reference
The issue at stake here is that we are printing money to meet our own obligations. If this scenario seems to good to be true, its because it IS too good to be true! Nothing is ever taken at no cost. This is a basic principal of economics - and actually in physics as well. For every action there is an opposite and equal reaction. Unfortunately, too often our financial policies fail to take into account the law of unintended consequences.
Printing money with the express purpose of buying treasuries and mortgage obligations has some positive effects. It drives down treasury rates which are linked to many other rates that affect consumers. If these rates are lower, the debt burden may be somewhat eased allowing business and consumer spending to pick up. At the same time, the purchase of mortgage securities helps to add liquidity to a portion of the economy that has been relatively tight. If mortgage rates come down and more capital is available for consumers, this could help to restart the economy and prop up home prices to some degree.
But there’s more to this story. Because you can’t just print money forever and have only benefits. The ugly side of this coin is inflation which is a difficult beast to tame. Up to this point we have been fortunate to see stability in prices. But if Bernanke and Co. is successful in re-establishing a working finance and economic engine, the next big battle will be against inflation.
Perils of Inflation
Now to many of us who have seen home prices and other assets decline (maybe your 401k assets?), inflation may sound like a godsend. But inflation has some nasty side effects that can devastate an economy. The first is the real value of money.
Suppose you spent your life squirreling away enough money to retire on. Suppose further that you were smart enough to be in treasuries during the last 18 months and you avoided Wall Street’s carnage. You’ve done everything right and been responsible. Then in a year, your $2 million dollar nest egg is all of the sudden worthless. That’s because it costs a fourth of that just to keep the lights on and enough food on the table.
In the early 1990’s I spent a little time in Budapest, Hungary. The country was beautiful, but the people were despairing. That’s because they were dealing with a very difficult inflationary environment. When people got their paychecks, they immediately went to the market to buy whatever goods they could afford. The issue wasn’t that they necessarily needed the goods right then. No, the problem was that tomorrow the money would buy fewer things. Everyone knew their currency was declining.
I hope that in the US we are not ever in that dire of a predicament, but the steps we are taking begin to lead in that direction. Money does not grow on trees, or fall out of planes, or even roll off printing presses (without consequences). So with this added stimulus from the Fed comes additional challenges. Stay tuned tomorrow for investment strategies to help you safeguard against long-term inflation.
