Published September 12, 2012
Wall Street seems to be the only place where another round of quantitative easing by the U.S. Federal Reserve Board is viewed as an out-and-out panacea for the world’s fiscal woes.
Stock markets have been moving higher in recent weeks based in large part on a belief that the Fed will once again loosen monetary policy Thursday at the conclusion of its September meeting.
The release last Friday of another disappointing monthly jobs report only strengthened the sentiment that the Fed has to do something significant. Rather than tanking after it was revealed the U.S. added a meager 96,000 jobs in August stock markets have risen on the notion that the lousy numbers will force the Fed’s hand.
But beyond the often-myopic view of professional stock traders there is considerable doubt that the Fed can stimulate the economy in any meaningful way through additional intervention.
Asked if he believed a big move by the Fed -- or any move by the Fed, for that matter -- could successfully rev the U.S. economic engine, John Ryding, chief economist at RDQ Economics, offered a one-word reply: “Nope.”
The Fed’s options include a third round of bond buying (or quantitative easing) in which the Fed buys U.S. government bonds in an effort to lower long-term interest rates and promote borrowing. More borrowing will ostensibly lead to economic growth.
This is the preferred strategy of Wall Street because low interest rates translate into easy money, which pumps up demand for goods and ultimately boosts company stock prices.
It’s universally accepted that Wall Street will soar on an announcement of another round of quantitative easing, commonly referred to as QE III, and sell off if the Fed disappoints by choosing a less impactful strategy.
Other options include extending the life of programs already in place, such as Operation Twist, in which the Fed shifted its portfolio toward long-term bonds also in an effort to lower long-term borrowing rates. The Fed could also announce its intention to keep interest rates at their historically low range of 0%-0.25% well beyond the late-2014 deadline now in place.
These latter two options allow the Fed to do something while essentially doing nothing.
Low Interest Rate Policies Hurt Investors, Especially Retirees
Bernard Kiely, a financial planner at Kiely Capital Management in Morristown, N.J., said none of the options listed above will benefit his clients, many of whom are retired and now living on fixed incomes.
“It’s going to reduce the income they’re earning on their fixed-income investments,” he said. “The people on fixed incomes are getting killed.”
Policies that seek to push interest rates lower than they already are punish investors -- notably retirees -- who have put their money in fixed-income securities such as bonds. Bond coupons, or the amount they return to investors, fluctuate as interest rates rise and fall. When interest rates fall so do coupons.
Kiely said he’s skeptical the Fed can do anything at this point to kick-start the economy. Far more important, he said, is for Congress to get its act together and negotiate a compromise on spending and deficit reduction that will avoid the so-called fiscal cliff looming in January.
The U.S. government faces dramatic across-the-board spending cuts next year as a result of a politically expedient deal cut in 2011 that allowed Congress to raise the U.S. debt ceiling. No one knows how the already-weakened U.S. economy will respond to such a shock.
“I believe if we go off the cliff we will go back into recession,” Kiely predicted.
Fed Chairman Ben Bernanke has taken pains to defend the sometimes unprecedented Fed interventions initiated since the worst of the financial crisis four years ago. But he has also made it clear in speech after speech that monetary policy alone won’t solve the ongoing global economic slowdown.
“Monetary policy cannot achieve by itself what a broader and more balanced set of economic policies might achieve; in particular, it cannot neutralize the fiscal and financial risks that the country faces. It certainly cannot fine-tune economic outcomes,” Bernanke said in a high-profile speech last month in Jackson Hole, Wyo.
Central Banks Have Lost Influence to Shadow Banks
Mark Williams, a former Fed examiner who now teaches banking at Boston University, said the European Central Bank may have taken some of the pressure off their U.S. counterpart last week by announcing a European version of quantitative easing, a move that also cheered stock markets.
In any case, Williams noted that the influence of central banks around the world has declined in recent decades with the emergence of so-called shadow banks whose ranks include hedge funds and venture capital and private equity firms.
Williams said less than 50% of the total amount of currency floating through the global economy is currently controlled by central banks. The rest is under the influence of the shadow banking system.
“It’s a little too late for the Federal Reserve to try and jumpstart the economy,” Williams said. “Even if QE III comes into play it’s not going to have any impact for two quarters. And then it’s suspect what the impact will be even then.”
During the first two rounds of quantitative easing the Fed increased its balance sheet to $2.8 trillion and the results have been strongly debated, not least among the members of the Federal Open Market Committee, which sets most Fed policy.
While most analysts believe the Fed’s aggressive moves since 2008 helped pull the U.S. back from the financial abyss, a strenuous debate has raged within the Fed over whether another round of fiscal easing will help or whether it will increase the likelihood of harmful inflation. A group of regional Federal Reserve Board members have loudly argued that the Fed should refrain from any more stimulus programs for fear of inflation.
Williams touched on elements of that debate. “We pumped $2.8 trillion into the economy. But did we get out of that what we put into it?” he asked.