We often get lost with monetary policy minutia and over analyze every twist and turn in our quest for answers. Recently I read an article at zerohedge.com about the "mechanics of QE3" that highlighted how Ben Bernanke's "hands are very much tied." Although I'm taking the article at face value, let's assume that the analysis is incorrect and that the Fed is successful in its implementation of QE3. Now let's take a step back in time.
On December 16, 2008, the Federal Reserve set the federal funds rate at 0%, and almost 4 years later the ZIRP policy has produced very little, if anything. The Dallas Fed made a specific case in a paper (pdf) titled "Ultra Easy Monetary Policy and the Law of Unintended Consequences," and whether one likes it or not, it had a point.
In the immediate aftermath of the bankruptcy of Lehman Brothers in September 2008, the exceptional measures introduced by the central banks of major AME's were rightly and successfully directed to restoring financial stability. Interbank markets in particular had dried up, and there were serious concerns about a financial implosion that could have had important implications for the real economy.
Yes, it's the same as saving the guy who decided to climb a remote mountain, and then had to be rescued because he either failed to calculate the risk, or he didn't care because he knew that he would be saved. Our tax money at work, although it's always for a good cause.
We must bring perspective to the Fed's track record and ability to understand the economy that surrounds us, and the Bloomberg article "Fed's Rate Increase May Reflect Rising Confidence in Expansion," published on July 1, 2005, makes a point.
"Pressures on inflation have stayed elevated," the Federal Open Market Committee said yesterday after raising its overnight bank lending rate to 3.25 percent in the ninth-straight increase in a year. The expansion "remains firm" even amid rising energy prices, the FOMC said in a statement in Washington.
Although the article included a reference that "Greenspan cited 'froth' in the housing market" on May 20, 2005, reality remained that the Fed never truly understood the problem. To that point, a speech delivered by Alan Greenspan on April 8, 2005, extolled the virtues of subprime as housing was headed for a cliff.
A brief look back at the evolution of the consumer finance market reveals that the financial services industry has long been competitive, innovative, and resilient. Especially in the past decade, technological advances have resulted in increased efficiency and scale within the financial services industry. Innovation has brought about a multitude of new products, such as subprime loans and niche credit programs for immigrants.
More recently, Ben Bernanke's speech at Jackson Hole added plenty of truth to monetary policy, and the translation of the excerpt below is simple: We don't have a clue as to whether this stuff works or not.
In sum, both the benefits and costs of nontraditional monetary policies are uncertain; in all likelihood, they will also vary over time, depending on factors such as the state of the economy and financial markets and the extent of prior Federal Reserve asset purchases. Moreover, nontraditional policies have potential costs that may be less relevant for traditional policies. For these reasons, the hurdle for using nontraditional policies should be higher than for traditional policies. At the same time, the costs of nontraditional policies, when considered carefully, appear manageable, implying that we should not rule out the further use of such policies if economic conditions warrant.
Stabilizing the financial system, as the Dallas Fed put it, is one thing, but stimulating the economy is another, and unless the consumer shares the view that the future looks brighter, nothing will ever move the economic dial. Although deflation is truly what the Fed has been fighting all along, what happens if consumer sentiment shifts while the Fed is looking in a different direction? Milton Friedman argued that "inflation is always and everywhere a monetary phenomenon" but that statement fell short, because it should continue with "as long as the consumer plays along." The proof is in the pudding. But instead of exhibiting an open mind, Bernanke embraces the only notions that he has ever known, as the Jackson Hole speech illustrates.
However, following every previous U.S. recession since World War II, the unemployment rate has returned close to its pre-recession level, and, although the recent recession was unusually deep, I see little evidence of substantial structural change in recent years. Rather than attributing the slow recovery to longer-term structural factors, I see growth being held back currently by a number of headwinds. First, although the housing sector has shown signs of improvement, housing activity remains at low levels and is contributing much less to the recovery than would normally be expected at this stage of the cycle.
As a small example, has Bernanke thought that money printing devalues the dollar, increasing the price of oil and gasoline that feeds directly into consumer sentiment, which in turn is in no mood to borrow and spend? That fact is unique to America because oil is priced in dollars.
We often hear about the Federal Reserve's dual mandate of price stability and full employment, and then wonder when did that take place. For the sake of expediency and easy access, I use Wikipedia to highlight the key factors in the "Humphrey-Hawkins Full Employment Act of 1978."
- Instructs the government to take reasonable means to balance the budget.
- Instructs the government to establish a balance of trade, i.e., to avoid trade surpluses or deficits.
- Mandates the Board of Governors of the Federal Reserve to establish a monetary policy that maintains long-run growth, minimizes inflation, and promotes price stability.
- Instructs the Board of Governors of the Federal Reserve to transmit a Monetary Policy Report to the Congress twice a year outlining its monetary policy.
- Requires the President to set numerical goals for the economy of the next fiscal year in the Economic Report of the President and to suggest policies that will achieve these goals.
- Requires the Chairman of the Federal Reserve to connect the monetary policy with the Presidential economic policy.
It's as if the Act was modeled after a list of goals that is given to an employee when the annual review is conducted, and if the list had been taken to heart over the last 34 years, maybe we wouldn't be where we are. I worked for a nice and impatient fellow a long time ago, and one day a presentation was made to the executive committee on a proposed technology investment. It goes without saying that the presentation was extremely well designed and rehearsed, but three minutes into it, and having barely stepped into the thick of the pros and cons, he interrupted and asked: "When do I get my money back?" Nobody had an answer. The beauty of a speech never compensates for the hard questions.
Now that we've heard and read many speeches, opinions and presentations, "a former vice chairman of the U.S. Federal Reserve summed up the key issue confronting the prestigious policy retreat" at Jackson Hole, as reported by Reuters.
"What is holding the economy back? Why is it that we've had such incredibly accommodative monetary policy for so long (but) we've had so little growth? I think it remains a puzzle," said Donald Kohn, who is now a senior fellow at the Brookings Institution think tank in Washington.
In other words, "When do I get my money back?" But maybe the latest bizarre revision to "Consumer Credit - G.19" by the Fed does allay the fears that consumers are not borrowing. The December 2010 spike is the result of non-revolving credit being increased by $145 billion, and the Fed's explanation is fraught with "sweet nothings."
(click to enlarge)
At least the revised data shows that low interest rates may be working, because total consumer credit finally surpassed the peak in 2008. However, the deleveraging is either concluded, or never took place, and maybe, just maybe, QE3 is unnecessary because consumer credit is growing.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.