Einstein supposedly described folly as doing the same thing over and over and expecting different results. Fed Chairman Bernanke is a learned man; surely he knows that bit of sage advice, but he had little choice when he declared the latest huge bond purchase program. He was the only game in town. His counterparts in the monetary/fiscal alliance were AWOL, a dissolute Congress and a president who is long on talk and short on accomplishments.
I had decided after his last big move that the monetary strategy known as quantitative easing was no longer newsworthy, so I would not write about it. Two recent articles changed my mind. The first comes from John Mauldin who writes insightful observations about economics and politics in his Outside the Box newsletter. He cynically dubbed the latest Fed move as QE Infinity. The plan is open ended, and it begins with the Fed buying $85 billion of bonds each month until employment improves. This puts $500 billion per year into the system, but it may come with unintended consequences, such as inflation.
Mauldin cites a recent op-ed piece in the Wall St. Journal written by five PhD economists with excellent credentials who strongly disagree with the current easing. In their opinion, the policy will leave the next secretary of the treasury with problems so daunting that even Alexander Hamilton would have trouble preserving the full faith and credit of the United States. To learn whether or not it will actually encourage banks to lend money or consumers to buy more houses or businesses to invest in new capital development when rates fall from 3% to 2.98%, you would need to ask Einstein.
The second source of my inspiration was Richard Fisher, President of the Federal Reserve Bank of Dallas. He spoke September 19 to the Harvard Club in New York. You can read the speech on the Dallas Fed's website. He is an outspoken critic of the latest move and particularly of Congress. They can't expect monetary policy to do the job of fiscal policy. His advice to those in Washington who are pawns of political motivation when only bipartisan efforts can do the heavy lifting, illigitimum non carborundum, the sophisticated version of "Don't let the bastards grind you down." Ditto that Mr. Fisher.
Critics find it easy to blame the Fed, but those cries are misplaced. A former Fed chairman said years ago that there are times when trying to stimulate the economy by adding more money is like pushing on a string. Yet there is a strong vocal chorus suggesting that the solution is just to add more string. Fisher referenced a Duke University study of corporate CFOs that asked their motivation in making business investment decisions. Not surprisingly, only 14% of the 887 surveyed listed interest rates among their top three concerns. Consumer demand and federal government policies commanded over 80% when combined. Even more disturbing, 84% of respondents would not even increase their planned capital investment if rates declined by 2%.
When you consider that bank prime is currently 3.25%, we do not have much room for hope that we will see corporate investments respond to QE infinity. And since investment needs to be the starter for increased hiring and consumer spending, we are relegated to, as one colorful executive described, a Velcro economy. We are going nowhere until we know where Washington is willing to go. November can't get here soon enough.
We are in uncharted waters, as Fisher describes our fiscal/monetary stall. No one knows that Romney has the answer. By now, we can say confidently that Obama does not. And the Fed, the only entity moving, is flooding the system with money. Corporate and private accounts are holding literally trillions of dollars in cash. This naturally raises the risk of inflation, but given our present state of inactivity, I see that as a long way off.
A more common warning is that the economy cannot overcome the negatives of high unemployment, low corporate investment and excessive debt. This encourages business, consumers and investors alike to keep their powder dry until the outlook is clearer. This is a safe play, but the result is a large allocation to cash with the risk that investors are likely to miss further stock market gains that I believe will occur within the next two years.
Students of finance know that there is a link between interest rates and the price/earnings ratio of stocks. The path is through the rate that we discount expected corporate earnings. Today's rates, which the Fed seems to think will stay at today's ridiculously low levels until mid-2015, take us to the conclusion that the market is undervaluing future corporate profits.
We have been through many difficult periods in the past, but resourceful leaders eventually succeeded in taking us to new highs. Today's problems are not intractable. Opportunity exists, and investors have many choices including veto power over their buys and sells. You can participate without making unalterable commitments, but this much is clear. You will not share in the growth if your money is in cash.