About this time last year - or perhaps 14 months ago as QE1 ended - the talk was about Fed tightening that was to come by the end of 2010. With the tsunami of spending out of the federal government still going full blast, one could assume the economy could handle a few less steroids from the central bank. Instead economic activity drooped, and the stock market (after flash crashing), had an awful summer. By late August, QE2 was hinted at strongly and it has been all (mostly) "good times" since. (I say that with sarcasm.)
As I look around we are in Groundhog Day. I hear the Fed and the financial infotainment industry believing that tightening will happen by the end of this year or early next. Now "tightening" is all relative - even if the Fed began selling inventory off their balance sheet, the Fed funds rate is at its lowest in history and the Fed still holds trillions of product. So we're simply talking from going from "ultra ultra ultra ultra easy" to "ultra ultra ultra easy."
Call me an outlier. I don't think it will happen. My belief is the structural economy is so dependent on easy money from the federal government spigot, plus super easy monetary policy) Nov 18, 2009: Our Economy is on Steroids) any true reversal of policies will lead to the same type of weakness (economic) we saw last summer, and the Fed will immediately panic. QE3 will be here. Indeed I expect it by next winter. Just about the time everyone believes The Bernank will "tighten."
We're running at a 10% annual federal deficit simply to push out paltry 2%-2.5% GDP growth. It's pathetic. If the government goes back to 3% type deficits (which I don't foresee but even a drop to 5%-6% will be a blow to the economy) the U.S. goes back into recession immediately. No one wants to take the "medicine," so QE infinity it is. Some say it is politically impossible - I say I disagree. More dollar weakness and commodity speculation? Yes. Is the Fed trapped in a box? Yes. But to appear to be useful the Fed has to do "something." They can't sit on their hands. And the only "something" they have left is the same thing.
Yes, the Fed policies will blow up the U.S. again down the road - I expect Bernanke to be viewed like Greenspan now is in due time - I wrote that 2-plus years ago. If the stock market corrects 12%-15% I expect an immediate QE hint in a speech. We'll see, perhaps I am wrong. But according to this story on CNNMoney, some of the sharp minds at Goldman Sachs (GS) agree with my outlier view on no "tightening" anytime soon. Indeed they don't believe the Fed will tighten until near the end of the decade. With a cyclical recession surely to hit sometime mid decade, I don't necessarily disagree with them on that count either. Where Goldman disagrees with me, is they believe no more QE ...
From the story:
- A report issued by economists at Goldman Sachs argues that a coming wave of government belt tightening, hailed by hawks everywhere, will actually keep central bank doves in control for a long stretch - perhaps well into the second half of this decade.
- The yawning U.S. deficit and the fear that tighter policy could derail a weak recovery could keep the fed funds rate near zero for perhaps six years, the Goldman research suggests. "The best the Fed can do is keep monetary policy on hold to cushion the growth drag from the fiscal consolidation," writes Goldman economist Sven Jari Stehn. "As a result, the looming fiscal adjustment should reasonably be expected to see policy rates - and probably longer-term rates too - at lower than normal levels for an extended period."
- With all the frothing about inflation, how on earth will Bernanke & Co. be able to justify staying on the sidelines? The answer lies in the unhappy math of a profligate nation out of control for so long that its excesses can't be trimmed all at once, no matter what the Paul Ryans of the world might claim.
- Even if our political leaders quickly agree on a package of spending cuts and tax increases – an outcome that doesn't look terribly likely right now, on debt ceiling day – it will take years to bring that massive deficit under control. Goldman cites an IMF survey of fiscal consolidations in rich countries that puts the average length of the successful government belt-tightenings at six years.
- That is a daunting enough statistic. But most of these successes – ranging from Ireland in the mid-1980s to Finland, Italy and Sweden in the mid-1990s – shared one notable characteristic: A cut in short-term interest rates that averaged five and a half percentage points. Pulling that lever isn't an option for the Fed, which cut its fed funds rate to its current level just above zero in December 2008.
- "With the funds rate close to the zero lower bound," Stehn writes, "a spending based adjustment could not be accompanied by monetary easing unless the Fed decided to adopt another asset purchase program (which we think is highly unlikely)."
- That means that even a successful U.S. consolidation could feature a Fed on hold for, all things considered, a decade. (just remember, we are not Japan.) If you start back in 2008 and figure it will take our solons in Washington the rest of the year to put together a plan for meaningful reforms, a six-year timeline means we could still be consolidating in 2018. And that assumes something gets done before next year's presidential election.
- It will also mean more trials for the dollar, which has fallen 10% against major currencies since Bernanke said in August that the Fed would do anything to boost domestic demand.