Mr. Bernanke, Chairman of the Board of Governors of the Federal Reserve System, warned us in Jackson Hole, Wyoming, that the Fed was not yet ready to move on QE3 at the time but would remain diligent in its analysis of the economic situation and should that economic situation require it, the Fed would not back off from moving into another round of monetary ease.
This past week the Federal Reserve introduced another round of monetary ease.
Conclusion: the economy must be in much worse shape than we thought it was.
The Fed's action is massive…an open-ended commitment to the purchase of $40 billion in securities per month indefinitely…and a view that the Fed's target rate of interest, the Fed Funds rate, will remain near zero out into 2015.
Let me focus on four pieces of information: industrial production; capacity utilization; labor force participation; and exports.
Industrial production is an index of the output of the industrial sectors of the economy. The growth pattern of real Gross Domestic Product tends to trace the growth pattern of industrial production.
In August, industrial production fell by 1.2 from the level it had reached in July. Some of the decline can be attributed to Hurricane Isaac. According to the release of the Federal Reserve: "Hurricane Isaac restrained output in the Gulf Coast region at the end of August, reducing the rate of change in total industrial production by an estimated 0.3 percentage point."
But, the monthly rate of change in total industrial production would still have been negative.
Year-over-year, the rate of growth of the industrial production index was 2.8 percent, the worst year-over-year rate of growth since the February 2010. The trend in year-over-year has been downward since February of this year when the rate of increase was 5.2 percent.
The index of capacity utilization captures the rate at which the United States is using its "installed" productive capacity. Capacity utilization dropped in August to 78.2 percent, below the level it was at in February 2012. For the last six months, however, capacity utilization has been roughly flat averaging about 78.5 percent.
The level of capacity utilization reached in the past six months represents the peak of capacity utilization reached in the economic recovery, which started in July 2009. This peak is below the previous peak in capacity utilization continuing the secular trend in capacity utilization begun in the early 1970s.
The civilian labor force participation rate dropped to 63.5 percent in August, a level of participation not reached since the middle of the 1970s.
I have written often about the amount of underemployment that exists in the United States. I have estimated this figure to be about one in every five individuals that would like to be employed. The underemployment in this country has trended upwards since the late 1960s. This figure, however, does not capture those individuals that are not looking for regular employment outside the home.
The civilian labor force participation rate captures the willingness of all civilians to be gainfully employed outside the home. This figure is the now the lowest it has been since more women began entering the labor force in the 1970s. More and more research is indicating that women are not so much exiting the labor force at this time as are men leaving the labor force.
All three of these data series point, to me, the presence of structural changes in the economy that require serious consideration. Mr. Bernanke has stated in recent months that these problems are not structural in nature but are cyclical. Mr. Bernanke and I disagree on this.
If the slow growth in the economy is just cyclical, then Mr. Bernanke has some justification of pulling out QE3 in an effort to combat what he considers to be a further cyclical weakening of the US economy.
If the slow growth in the economy is due to structural problems then QE3 will not bring about the changes in the economy that are necessary to bring about a more robust rate of economic expansion. The consequences of the new round of quantitative easing will only bring about inflation, and not necessarily inflation in the prices of output, but inflation in the prices of assets.
Inflation where? Inflation in stock prices, commodities, or housing prices? We'll see.
But, inflation in asset prices does not necessarily create more employment especially if the reason for the under-utilization of labor - and capital - are structural in nature.
This would be the Fed's second blunder in interpretation since 2008 that has resulted in the situation we are now in. The first blunder occurred as the financial collapse took place. The Fed interpreted the financial collapse of late 2008 as a problem of liquidity and not of solvency. As a consequence, the Fed tossed all it could, all the "spaghetti" in the house, against the wall to see what would stick. This prevented at the time a greater collapse of the system, but the problem of solvency stills hovers over us in the banking system, in real estate, and in the household sector.
This second blunder, I believe, is the Fed's claim that the economic problem is just one of cyclical nature and not a structural one. Again, the policy is to throw as much "spaghetti" against the wall as possible to see what sticks. My guess is that this policy will accomplish very little and we will still be dealing with structural economic problems well into the future.
The further piece of information coming out this past week was the decline in United States exports. US exports have been declining since the third quarter of 2011. In July 2012, exports dropped to a year-over-year rate of increase of 2.8 percent, down from 6.9 percent in the first quarter of this year and down from 5.2 percent in the second quarter.
US exports are reflecting the slowing of growth in Europe and the rest of the world.
The Fed's response? If we can inflate the economy and cause the US dollar to decline in value, this will help to make US exports increase because of the cheaper dollar.
Well, the value of the dollar did decline on both Thursday and Friday by fairly substantial amounts. As I expected, the foreign exchange market graded another round of quantitative easing as inflationary. Hence, I was not surprised at the movement.
So, here we are again. We have a severe problem: the United States economy is not in very good shape. We have the Fed's actions to back up this conclusion. Our economic future will depend upon, as will our individual investment decisions, whose interpretation of the current situation is correct. If the problem is cyclical, as Mr. Bernanke proclaims, then maybe QE3 will result in rising economic growth and lower unemployment. If the problem is secular then QE3 will do little to help the economy improve and will result in further asset price bubbles without resolving our fundamental structural dislocations.