No Matter What The Unemployment Rate, The Fed Will Have To Taper

by: Mingdong Wu

Although many may believe that the unemployment rate is the key to the Fed's decision on the timing of tapering and Friday's softer-than-expected job report may delay the Fed's plan, I think the Fed will have to start tapering for a different reason.

Quantitative ease is a monetary tool used by the Fed to boost economic activities in the US. Under the latest QE program announced by the FOMC in December 2012, the Fed is buying $85 billion of US treasury securities and agency mortgage-backed securities from qualified institutions per month. The full impact of such monetary policy to our society is often misunderstood by the public.

As any monetary tools, QE does not directly create new jobs or increase economic activities. The logic of QE works as follows, in sequence: strengthening bank balance sheet by relieving commercial housing market debt risk and injecting liquidity, to boost asset prices for housing and stock, to boost consumer and business confidence, which eventually leads to increase in consumer spending and business investments to create jobs and boost economic activities. That's all with good intent.

However, the side effect of such monetary policy is to benefit the wealthy class of population more than the working class. The increase in asset price, both for stock and housing, will directly benefit those with capital to invest. For people who work paycheck-to-paycheck, the benefit is indirect and if any, may take a long time to arrive. Initially, it may even increase hardship for the working class by reducing the purchasing power of their paychecks due to inflated housing prices.

Therefore, while the current monetary policy by the Fed is effective in times of financial crisis to address liquidity-caused recession, it deepens social inequality and thus may not be viewed favorably by the current democratic administration. Maybe that's why President Barack Obama said in June that Bernanke has stayed "a lot longer than he wanted to or he was supposed to".

The Fed surely understands the above negative side effect caused by quantitative ease. Once the financial market confidence is restored, the increasing negative consequence of QE (i.e. social inequality) could far outweigh any incremental benefits of additional liquidity from QE. Therefore, as housing prices and the stock market approach pre-crisis levels, the Fed will have to taper no matter what the unemployment rate.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.