Federal Reserve chief Ben Bernanke
Everyone is talking about Larry Summers’ dropping out of the race to become the next Federal Reserve chief. A more immediate and salient question, at least for the market, is whether or not Ben Bernanke will start turning off the Fed’s money spigots this coming Wednesday after the bank’s board-of-governors meeting. Just a few months back, when Bernanke no more than hinted that the Fed’s program of “quantitative easing” (QE) — an $85 billion-a-month Treasury-bill and mortgage-backed-securities buying spree — would be curbed, markets reacted violently.
This speaks to the fact that QE, which has been done in three rounds since the financial crisis, is considered by many to be one of the key reasons that the stock market has done better during the post–Great Recession “recovery” than the real economy itself has. As I explained in May, what’s been bad for the real economy — namely sluggish growth, persistently high unemployment and flat wages — has bolstered the stock market since the weakness of the real economy has led the Fed to keep pumping money into the system.
The big question of course is whether we’ve reached a point of diminishing returns. While most smart economists I know say that the first round of QE did help bolster the real economy, many like Morgan Stanley head of macroeconomic research Ruchir Sharma believe that subsequent money dumps have done more to create asset bubbles than real growth. (See, for example, how the Nikkei and later a number of emerging markets including India crashed after the Fed started to talk about pulling back from its asset buying.) What’s more, if you consider that 75% of the stock market is owned by the wealthiest quarter of Americans, QE may have actually increased inequality.
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Of course, there was nothing nefarious about QE. In a polarized Washington incapable of passing a real-job-creation plan or any further stimulus, Bernanke probably felt like the last man standing who could do something to bolster the economy. Hence, his tendency to throw as much firepower as he could at the markets. Indeed, plenty of economists felt he should have announced a more unlimited “shock and awe”–type asset-buying program earlier on, rather than announcing QE in three rounds, leaving markets jittery about when and how it would be pulled back. Others, like myself, have written that a greater focus on the mortgage markets earlier on might have helped bolster its effect too.
But whatever we “coulda, shoulda” done differently, it’s almost certainly time for the money spigots to be slowly turned off. Sure, August jobs data was lousy, but it’s a volatile month that often gets revised upward after the fact. Meanwhile, good news in the manufacturing sector and increases in consumer-and-business confidence mean that I’m putting my bet on some hint of “tapering” of asset buying after the Federal Open Market Committee meeting (though we probably won’t see an interest-rate hike for a while). What’s more, I think an interesting conversation will start to emerge about what the current 7.3% unemployment figure is really telling us. Chairman Bernanke has said in the past that he thinks it underestimates how bad the labor market still is, because it could reflect a rise in underemployed and discouraged workers dropping out of the market, rather than full-timers getting real jobs. The market has rallied in the past couple of days on hopes that new Fed chief front-runner Janet Yellen will get the job and keep the spigots on longer than Summers would have. But that belies the fact that Yellen doesn’t yet have the job — and it’s Obama’s to give. Summers is over, but the markets may yet have a fall.