Curious Capitalist

Foroohar: Turn Off the Money Spigot

Markets cheer end of Larry Summers, but a slowdown could be around the corner

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Manuel Balce Ceneta / AP

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.

(MORE: How to Lose $30 Billion in 18 Months)

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.

5 comments
JohnDavidDeatherage
JohnDavidDeatherage

Since 1977, the Federal Reserve has had a dual mandate; create full employment and control inflation.  In trying to achieve the mythical "full employment' the Fed's easy money policies have created asset bubbles.  When these bubble burst, they bring the economy down with them.

Let's go back to a single mandate for the Fed; control inflation.  It's time to recognize that employment is not a goal but a by-product of economic activity.  When full employment is the goal of the Fed, they use the tools at hand (monetary policy) to pursue it.  Asset bubbles and crashes are the result.

bryanfred1
bryanfred1

The cost of money (i.e. interest rates) has not been the issue for a long time.  It doesn't matter how low rates are when you're concerned about your ability to pay the debt back; you're not going to borrow in the first place.  Same with businesses that have no real productive use for newly borrowed funds.  The runup in housing prices has been almost entirely a monetary event - historically cheap rates have pushed prices up much more quickly than the pace of economic recovery justifies.  I'm concerned that even recent purchasers will find themselves losing equity or potentially underwater if rates increase even modestly as the Fed backs off its pace of buying.  Trying to use housing to push economic activity is a mistake - home purchases are a symptom of prosperity, not a creator.

jdyer2
jdyer2

The thing about QE that really bothers me is when I read about how tapering will badly effect emerging economies- they are relying on it to grow.  I read that the threat of a US taper has caused the Rupee to crash.  I would conclude that this US program is not out there to benefit the US, but is allowing the 1%'ers to invest overseas and create their jobs there rather than the US. 

j45ashton
j45ashton

Most of the financial community has been handled with kid gloves and I suppose for good reason given its ongoing, 'too big to fail' systemic importance to our economy.  However, QE has gone on for a long time now, and it feels as if it's time to dip a toe in the water and start cutting back & judge the results.

About the kid glove treatment...for both Obama & Bernanke prosperity on the stock market has been regarded as one way to pull us out of recession.  After all, as of the rise of the Nasdaq in the 90's, a lot more 'regular' people have been invested in the market through their 401Ks and when the market is up, people tend to spend more.  So anything that might disrupt the market that could be controlled has been avoided.,,including criminally prosecuting the executives of the financial community  for their roles in what occurred.  

It's been five years since the start of the financial crisis.  I hope the justice dept won't feel that the statue of limitations has run out.  There have been none of the criminal indictments that the public expected.  Speaking about TARP & Paulson's new book on Meet the Press, Barney Frank stopped the conversation cold when he asked, "if the banks were doing so poorly at the time of the crisis, why did the bank executives see fit to pay themselves such large bonuses and salaries."  Many of us are still waiting for justice to be done.

Adam_Smith
Adam_Smith

An old teacher of mine once told me that "those with poor minds talk about people, those with better minds talk about events and those with the best minds talk about ideas". So it is perhaps unsurprising that the top story is the career prospects of Larry Summers followed sporadically by the prospects for Fed tapering with hardly any discussion of the implications for the economy. So it goes.