Lost in all the hubbub about yesterday’s downgrading of the economy by the Federal Reserve and the announcement of what some call the beginning of QE II (i.e., quantitative easing, round two), in which the central bank will take $200+ billion in MBS paydowns over the next year or so and use that money to buy long-dated Treasuries, was news that the Fed now has a double-dissenter in Kansas City Federal Reserve President Thomas Hoenig.
In yesterday’s policy statement, Hoenig expressed his displeasure with both the Fed’s low rate guarantee and with the new plan to buy more U.S. debt with MBS proceeds:
Voting against the policy was Thomas M. Hoenig, who judges that the economy is recovering modestly, as projected. Accordingly, he believed that continuing to express the expectation of exceptionally low levels of the federal funds rate for an extended period was no longer warranted and limits the Committee’s ability to adjust policy when needed. In addition, given economic and financial conditions, Mr. Hoenig did not believe that keeping constant the size of the Federal Reserve’s holdings of longer-term securities at their current level was required to support a return to the Committee’s policy objectives.
While some have applauded the stance that Hoenig has taken recently, the inflation hawks are clearly in the minority at the Fed and, in the end, their efforts are likely to amount to only token resistance to gunning the printing presses as the economy weakens further, particularly since uber-dove Janet Yellen will soon hold the second in command spot at the Fed along with two brand new inflation doves.
Hoenig fears a repeat of what happened in the middle of the last decade, that is, an unhealthy rise in some asset class or other destabilizing developments due to extraordinarily easy monetary policy by the central bank at a time when deflation fears were gripping policy makers.
As shown below, what the Greenspan Fed didn’t know or care about back in 2002 and 2003 was that home prices were charging ahead at 10-15 percent a year while they were worried about the consumer price index dipping into negative territory.
Fast forward seven or eight years and, despite the push into positive territory in 2010, there is little fear at this point that these annual home price gains are about to surge into that dangerous double digit area again. Absent the government’s “paying people to buy houses” stimulus effort, most analysts look for price weakness ahead with a growing consensus that all of the recent home price increases will be given back and then some.
Back in 2002 and 2003, this inflating asset bubble was fairly easy to spot, that is, for those who were willing to consider the idea that home prices could go down as well as up.
Today, with the notable exception of bonds, there are no clear asset bubbles forming, however, it could well be that the fixed income market is what Hoenig is concerned about and, when you think about that possibility, it should send shivers down your spine.
After the housing boom and bust, conventional wisdom everywhere in the world outside of the Federal Reserve now posits that easy money policies indirectly contributed to the housing bubble’s inflation and its unseemly demise.
This time around, the central bank could be helping to inflate another bubble directly…
