The Fed made it clear that one of the transmission mechanisms for its policy is asset prices. More specificity, the Fed aims (hopes) that housing prices will increases and that will incite people to consume and invest
Below is the transcript of the Q&A session after the FOMC statement for September 13, 2012. The conversation is between Pedro da Costa from Reuters and Ben Bernanke:
QUESTION: My question is -- I want to go back to the transmission mechanism, because speaking to people on the sidelines of the Jackson Hole conference, that seemed to be the concern about the remarks that you made, is that they could clearly see the effect on rates and they could see the effect on the stock market, but they couldn't see how that had helped the economy.
So I think there's a fear that over time this has been a policy that's helping Wall Street, but not doing that much for Main Street. So could you describe in some detail, how does it really different -- differ from trickle-down economics, where you just pump money into the banks and hope that they lend?
BERNANKE: Well, we are -- this is a Main Street policy, because what we're about here is trying to get jobs going. We're trying to create more employment. We're trying to meet our maximum employment mandate, so that's the objective. Our tools involve -- I mean, the tools we have involve affecting financial asset prices, and that's -- those are the tools of monetary policy.
There are a number of different channels -- mortgage rates, I mentioned other interest rates, corporate bond rates, but also the prices of various assets, like, for example, the prices of homes. To the extent that home prices begin to rise, consumers will feel wealthier, they'll feel more -- more disposed to spend. If house prices are rising, people may be more willing to buy homes because they think that they'll, you know, make a better return on that purchase. So house prices is one vehicle.
Stock prices-- many people own stocks directly or indirectly. The issue here is whether or not improving asset prices generally will make people more willing to spend. One of the main concerns that firms have is there's not enough demand. There are not enough people coming and demanding their products. And if people feel that their financial situation is better because their 401(k) looks better or for whatever reason -- their house is worth more -- they're more willing to go out and spend, and that's going to provide the demand that firms need in order to be willing to hire and to invest.
Whether or not higher asset prices (house and stock prices) will make people spend more is very debatable. My feeling is that this crisis has changed mentalities and spending habits and if I am right, even if asset prices do increase, people will continue to be reluctant to spend, unless of course they have the income and feel comfortable with spending money, but without going into debt.
The Fed of course can pump money into the markets (as it is doing), but that will not necessarily go into the economy. Take a look at the M2 money velocity chart below. Please not that it is at record lows. If money velocity is an indicator of turnover in the money supply, then clearly Fed's policy is not working.
Let's look at house prices. For all the QEs and the low rates, house prices are still at very low levels. My question is, if all the easing didn't work until now, why does anyone think it will work next time around?
Also, look at the household debt to GDP chart below. People are still deleveraging. Not necessarily because they don't have money, but probably because people have changed the way they feel about debt.
For whatever reason, people do not want to take on more debt. And as far as the chart below is concerned, my hunch is that the deleveraging has more to do with banks writing off loans than people actually paying off their loans.
And no wonder people are reluctant to take on more debt, they are still struggling to pay of mortgages from the previous housing bubble (chart below).
The Fed has a very difficult job. It is out of tools and out of options. I don't know exactly what will take in order to return to normal levels of previous economic circles, but the fact is that the man on the street is not benefiting and still does not feel any relief.
As far as the market is concerned, these charts are not necessarily bearish. Like I said in the beginning, even if the Fed transmission mechanism is not working as the Fed would like, the money is indeed going into assets. So it is possible to see the major indices much higher, even though unemployment is still high and housing prices are still depressed.
How high, however, is another question, because until companies and money managers are convinced to spend the pile of money they have on the sidelines, there are limits to how high stocks can go, no matter how much money the Fed pumps into the market
Please take notice that I am not criticizing the Fed. The Fed has a bunch of very smart people working for it and I am sure they are doing all they can to revive the economy. However, as the above data shows, simply buying assets isn't enough to revive the economy, to previous levels, of what was once considered the norm.
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.