Let me first start by saying that I have been an adamant supporter of Ben Bernanke and the Federal Reserve. With the prolonged effects of the "Great Recession" hurting the vast majority of Americans and the increased popularity of Congressman Ron Paul along with others who have more extreme positions on the economy, defending the Fed (especially its independence) has become something of a mission for me when ever such discussions arise in my social circles.
However, after the announcement Thursday that the Fed will undertake QE3, a very aggressive, open ended, $40 billion monthly mortgage-backed debt purchasing program intended to kickstart the housing market (and with it the U.S. economy), I must ask the question - are they insane? Apparently, the answer is yes. It is said that the definition of insanity is doing something over and over again hoping for a different result. Although this third round of QE differs from 1 and 2 because it focuses solely on mortgage related debt, it is still a ridiculous notion to think that this will do anything more than inflate the equity markets like both QE1 and QE2, as the Dow being up over 200 points on Thursday proved. What this third round of bond buying has made me do is:
a) question the rationale behind the Fed's mandate to achieve maximum employment and
b) question whether anyone involved with the Fed attended economics or history classes while in school
If there is one word to describe an economy, it is this: confidence. What the Fed has failed to realize (or do its homework on) is the simple fact that, much like the Great Depression, the Great Recession was a "balance sheet recession." What does that mean? Well, it is simply a recession that is fundamentally rooted in too much leverage. Individuals, corporations and governments had too much debt on the books. The reaction when the muck hits the fan (as it did in 2008) is a deep crisis followed by a slow, sometimes painfully slow, recovery. The reason for the slow recovery is simple: deleveraging. Every entity is in the process of deleveraging. However, where corporations can deleverage quite quickly if need be, individuals and governments are less capable of doing so. In an economy that is 70% consumption with a consumer that is unable to consume, why is there such surprise that sectors of the economy, especially housing, are slow to rebound? Whatever happened to letting the economy take its natural course. If that means a slow housing market, so be it. If that means unemployment stays elevated for a while, so be it. Companies were bloated. Now those companies are leaner and meeting demand with less employees. Why on earth would companies start hiring if there is no large increase in demand from a consumer who is deleveraging and lacking in confidence?
While I believe in an independent Fed and am baffled at all the "end the Fed" nonsense, I do have to call into question the rationale for the Fed to "maintain maximum employment," which is a part of the dual mandate. I have never quite understood exactly how maintaining price stability and maximum employment fit in together, probably because they don't. In 1977, Congress amended the Federal Reserve Act to include the goal of maximum employment. As usual, Congressmen wanted to lessen their workload (Congress could do much more to ensure maximum employment then the Fed). An article in Forbes by Tom Wilson, CEO of Allstate and a former board member of the Chicago Federal Reserve Bank is the best explanation I have seen for requiring the Fed to have a single mandate.
Now, it should be stated that the Fed definitely helped prevent what could have been a serious depression in 2008. If you are reading this article, I am sure you have some idea of the precipice the global economy was heading towards. However, Bernanke of all people should known, having studied in depth about the Great Depression, that even though the economy was steered clear of absolute disaster doesn't mean that it will (or should) come roaring back, no matter what form of stimulus is provided. As I mentioned earlier, confidence is the key. Consumers are still not that confident and may not be for quite some time. This is healthy. It is called the economic cycle. Maybe those in power should quit fighting it and realize that the "great moderation" of the late '80s and '90s was not some miracle created by policymakers but just another part of a cycle that is unpredictable and, unfortunately, sometimes quite painful for many people. What will be more painful is the inflation that could very well be on the horizon. I thought after QE2 that inflation was not an inevitability. With QE3 and further action when it doesn't work, it looks like it is.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.