The monetary policy debate continued on Capitol Hill Wednesday as Fed Chairman Ben Bernanke gave his bi-annual speech to Congress. Bernanke continues to wait for U.S. employment to return to trend, using many of the tools in his arsenal. In his statement he reiterated his commitment to quantitative easing and explained that the tapering of the current program is not imminent, and austerity is generating a fiscal drag. We remain very skeptical that these are the path to sustainable growth and that nothing short of allowing a mass write-down of much of the debt is the way out. Unfortunately, that is not the role of the central bank.
The chairman commented about the gap between supply and demand for technical jobs within the United States. Technical education allows intelligent people from around the world to come to the U.S. and participate in the U.S.' technical innovation. The overall trend, however, in technical jobs is from the design side not the manufacturing side of the equation. Companies such as Apple (AAPL) and Google (GOOG) produce engineering design jobs but the implementation side of technology manufacturing happens outside the U.S. Apple's decision to move one factory back to the U.S. we feel is more a political move than a competitive one.
Chattanooga, TN is now known as Auto Alley with the number of auto manufacturers around there, including Volkswagen (VLKAY.PK), GM (GM) and Nissan (NSANY.OB) and attendant supporting industries needed to manufacture cars present as well. And while there has been a short-term boom in auto sales in the U.S. due to the low cost of non-revolving credit this is not sustainable in the long term and these manufacturing businesses
One way to view current U.S. monetary policy is a stimulus that is offset by austerity. Government jobs and spending, which is part of the Labor Department equation for producing non-farm payrolls, is at its lowest levels since 1968. The U.S. is paying down its debt, as mandated by the president and Congress, while the Federal Reserve is simultaneously attempting to spur above trend growth. It seems logical that austerity would generate a head wind for growth, which makes it more believable that quantitative easing will continue to be necessary to attain the status quo.
Because of the Fed's accommodative monetary policy we now have a corporate bond yields at record lows. High yield bonds (JNK) crossed through the 5% level in April for the first time in history. Borrowing continues to work its way into corporate America, which the Fed is hoping will stimulate private sector payrolls. But, in reality, this low cost of capital is simply blowing another risk-insensitive bubble in corporate debt. But since QE is designed to be a war of savings of all kinds to fight the specter of deflation, now that the Fed has crushed personal savings it is time to go after corporate savings as well. Cue Tim Cook's trip to Capitol Hill earlier in the week.
Unfortunately, mortgage lending, according to Chairman Bernanke, is still too restrictive, which is providing headwind for residential housing. With falling money velocity and excess reserves held at the Fed higher now than just after the fall of Lehman Bros., one has to wonder just what Bernanke is thinking when floating the idea that they can stop QE at some point in the future? He knows the banks cannot lend out the new cash as most of it is being used to swap out toxic mortgage-backed securities for U.S. Treasuries to shore up the banking system's Tier 1 capital ratio. But that is simply accounting with the Fed acting like a Resolution Trust dumping ground for worthless debt which it will never be able to sell.
And Bernanke knows this.
This accommodative monetary policy is creating a wealth effect for those who have exposure to the equity markets, which the Fed truly believes is the driver of the economy and not a reflection of underlying economic health. It is this type of cart-before-the-horse thinking in modern Keynesian/Monetarist thinking that creates the kind of misguided policy we engage in. This type of wealth effect is a top down approach which is reflected in the current stagflationary environment we are experiencing now - high unemployment, historically high commodity and energy prices and low money velocity brought on by over-consumption and over borrowing. And despite the historic rally in the S&P 500 (SPY) and the Dow Jones Industrials (DIA) retail investors have still not returned to stocks because they have no money to spend.
Bernanke was asked if ultra-accommodative policy was the reason for an elevated stock market, to which he responded that possibly investors perceive that accommodative policy will continue to produce significant corporate profits. In other words, yes. The only yield that is out there thanks to the current policy is in the form of the equity markets. Recent bond offerings from Chinese oil giants CNOOC (CEO) and Sinopec (SNP) were many-times over-subscribed.
One of the key takeaways is that Chairman Bernanke believes that monetary policy is not a panacea for producing long term growth. He can say that again. Policy can mitigate the effects of the financial crisis, but without a fiscal policy that is geared toward employment, the combination of austerity and accommodative policy will produce a stale mate for economic growth, which is where we are now. People like Paul Krugman will say spend more money while the Austrians will tell you write down some of the debt and cut back on spending.
A full-on, let-the-bankers-hang, scenario of complete debt implosion would be the extreme Austrian position, but there is neither the political nor market will for that at this point. The EU-style solution of extreme austerity mixed with full creditor bailout is simply tyrannical and not recommended. Much to Bernanke's credit he has not advocated this, unlike Angela Merkel and the Germans. However, until and unless there is a move away from this politically-motivated tug-of-war where every dollar of spending cuts is fought for like a drowning man fights for air, the probability of the market taking action against the current stasis rises and with it the potential for catastrophe.