The Federal Reserve Bank isn’t supposed to be political. But, of course, it is. Just look at the recent decision to delay “tapering,” or scaling back the $85 billion a month asset buying spree that the bank has been on for many months now. The Fed says that underlying economic data isn’t yet strong enough to support it turning off the easy money spigots. But there has been plenty of good news recently, from the manufacturing rebound to the fact that initial jobless claims last week were down, to the uptick in August’s Leading Economic Indicators numbers. Even credit activity, tight since the recession, is slowly but surely starting to improve.
So what is Fed Chairman Ben Bernanke thinking? I suspect he’s thinking what he’s been thinking for several years now—that he’s the only person in Washington that has the power to do much to help the economy. Our polarized and dysfunctional politics continue to play out over and over again in the same way. Just look at the new debt ceiling wrangle that (once again) threatens to downgrade trust in our system, and at some point, trust in the dollar as a reserve currency. The Fed is fearful of “a Beltway bombshell,” wrote Kristina Hooper, head of investment and client strategies for Allianz Global Investors in a recent client note. Indeed, in an announcement last week, the Fed cited possible “fiscal headwinds” as a reason for not tapering.
It’s also worried about housing. The first hint of tapering a few weeks back led to an immediate uptick in longer-term interest rates, which resulted in a drop in mortgage applications and dampened enthusiasm about the housing recovery. As Warren Buffett said to me once, “If you fix housing, you can fix the economy.” Bernanke and a number of Fed governors clearly feel it’s their duty to keep housing on track, or the recovery will be at risk. Would that the administration would have done more for homeowners earlier in the recovery—if they had, the Fed might not have to use monetary policy as a lever now.
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But as I wrote in a column a few months ago, it’s a chicken and egg situation—in order to have a real housing recovery, you need lower unemployment and higher wages. And that requires real productivity growth, investment, and (ideally) more job-creating stimulus. None of those things are happening now. We’re still in a 2% economy, and that’s a structural issue that the Fed can’t fix.
Meanwhile, even the sugar rush of the asset buying is largely depleted. It’s telling that the rally in U.S. equities that followed the Fed’s decision not to taper last week was shorter lived than those that came before. And the flow of money in the real economy is largely flat—if quantitative easing were working to the extent that it should at these levels, we should be awash in money. All the while, the downside of asset buying—certainly bubbles but also all sorts of unintended consequences that we can’t imagine because we haven’t been here before—continue to build. They are compounded by the fact that other nations, like Japan, are conducting their own QE programs. Indeed, you already see the rubber hitting the road in this regard, with a majority of Senators asking President Obama and Jack Lew to push back against Japanese “currency manipulation.”
Those are fighting words. Currency wars can lead to trade wars, and trade wars are what can plunge countries into downturns. I wrote about this possibility in my very first Curious Capitalist column three years ago. I hope it’s not finally coming to pass.