By Shawn Carpenter
Fed Chairman Ben Bernanke hinted that U.S. interest rates will stay near zero for an "extended period" of time last week. This doesn't come as a surprise to most market observers. The Fed Funds rate has been near zero since December 2008. The low rate policy is meant to spur the economy as we continue to recover from the financial crisis.
But while the Fed's money powers are enormous, it has been rendered far less influential on the economy as a whole than in recent recoveries. Why?
For one thing, American companies have become so efficient -- more so with each downturn -- that they don't need to add workers much as the economy rebounds. Jobless numbers stay high, and that slows consumer spending growth. The jobless rate -- and widespread fear of losing one's job -- have consumers, quite rationally, afraid to spend or borrow.
Also, these same companies are increasingly global, so even as they're growing and reporting record profits, the impact in the U.S. is muted. Companies avoid paying taxes on foreign profits by keeping funds parked abroad. So, U.S. government tax revenue is reduced. And many companies boost production abroad, not here, so employment isn't helped much.
Thus, the Fed's easy money helps the companies, but less so the broader economy. This de-linking of Corporate America's prospects from Main Street's prospects still hasn't been factored into economic policy making much.
What's more, the magnitude of the residential real estate mess -- and the relative puniness of government efforts to clear it away -- are holding back a housing rebound. Debt restructuring for mortgage holders under water turned out to be small. And real estate busts always take more time to work out than securities crashes because the market is less liquid and owners have reasons (shelter among them) to hang onto the assets. So, easy money can't solve this problem by itself. The early '90s California housing crash -- a 30% decline in values -- took years to work itself out.
Finally, the economic stimulus package didn't encourage enough job creation. Not surprising. It was a bandaid.
Below we look at the impacts of the Fed's policies of ultra low interest rates and increasing money supply.
Fed Lowers Rates to Get the Economy Moving
With the fed funds rate near zero, it can't go much lower. Given this, the treasury has added to the monetary base via QE1 & QE2. The chart below show how dramatic this move has been. The monetary base has increased by $1.8 trillion in the last 2 years with the treasury printing lots of greenbacks.
Federal Reserve/Treasury Print Lots of Money
As you would expect, when you increase the monetary base by printing money the value declines. Basic supply and demand. Below is the trade weighted exchange for the dollar.
Dollar Weakens As Money Is Printed
To make matters more troublesome, our Federal Debt has reached unprecedented levels and is at the debt ceiling which will have to be raised.
Need to Raise the Debt Ceiling
Initially, the fed moves appeared to be working, with Real Gross Domestic Product Growth rebounding strongly, but there are signs that the growth is slowing. The combination of ending QE2, continued unemployment and the spike in oil prices is putting a drag on the economy.
The monetary moves have had little impact on the jobs situation.
Unemployment Rates Remain At Highs
Housing Starts At All Time Lows
Real estate prices rebounded with the lower rates and quantitative easing but appear to be heading south again. A significant portion of home sales are at low prices and driven by investors.
Real Estate Prices Head Lower After Initial Rebound
So if you follow the money trail you find that even though we added $1.8 trillion to the monetary base the capital remains trapped inside the large banks which have been buying stocks and commodities. Look at the gains we are seeing in the stock and commodity markets. Everything is up.
The Cash Is Moving Stocks And Commodities Up
Banks are reluctant to lend to consumers -- who, in truth, remain stretched -- at this point given the uncertainty in the economy and real estate markets. Banks already hold a huge amount of mortgages on real estate and aren't jumping for joy to add more.
Banks Are Flush with Cash But Won't Lend It
The side effect of all of the money supply and low interest rates is that commodity prices continue to rise, which is hitting the middle class rather hard. And with consumers making up 70% of the economy, this is a real drag on real economic growth. We have printed a lot of money but the impact looks muted at this point. The Fed, unlike the President, can intervene in the economy without the consent of Congress. But the central bank's ability to turn monetary policy into economic growth has been reduced by globalization and the reduced reliance on U.S. workers among large employers.