What to say about Fed policy? The Fed surprised the markets last week by not starting a tapering program. Apparently Miley Cyrus also surprised the markets by not taking proper dancing lessons. Anyway, the result was that the stock market surged on that day and interest rates fell. The next days saw a reversal but stocks remain at record levels.
Why do markets seem to love bad policy? Wait you say – stalling on tapering is not bad policy. The markets know that a tapering program today would be terrible for the markets. After all, the US economy has a zillion problems and therefore the Fed is the only game in town. The Fed cannot risk the recession that might ensue if they started tapering. That is the story I keep hearing. While I buy that many investors believe this story, that doesn’t make it right. Tapering is the right thing to do despite stock market hyperventilation.
So let’s pretend this popular story is a big ribeye and dig in. Let’s talk about the many problems that make the FED worry about recessionary risk. One thing mentioned is the government standoff. Maybe there will be a budget shutdown. Another problem is Syria and how future developments might affect oil flow and energy prices. Then there is long-term government budgeting that promises a rising national debt. What about a declining labor force? And Kim Kasrdashian?
There are many problems that threaten a recession. They are as real as that roll around your belly. But let me ask you this. Can you name many months or quarters in the past 50 years in which we were not plagued by similar risks. How many months or quarters in the last 50 years were we absolutely sure a recession was not around the corner? I would say not many. I also ask you how many times we were five years into a recovery and we were still worried about a double dip recession? Again, not many.
So why the paranoia today? One reason for the continuing worry is that we had one helluva financial global meltdown. It was not your mother’s recession. This was a perfect storm recession from which some people believe or believed we would never recover. But we did recover. While we are not happy with the strength of the recovery and its impacts on employment, income and poverty, the economy has recovered and grown. These years of growth should reduce some of the paranoia. But not all of it. We are not growing properly and something needs to be done.
A lack of money in the economy is clearly not our problem and therefore seemingly endless monetization of the economy is not what needs to be done. If pouring a container of water on a grease fire does not work then why would pouring two containers of water on a grease fire work better? Notice that we have had substandard economic results despite unprecedented infusions of money. So now we are going to do more? The reason the monetary solution worked in 2008 but not today is because the problem in the US today is not monetary. Keeping interest rates low might be good for the stocks, houses, and cars, but if we keep this up many of us will be leaving pretty houses each morning and driving our nice cars to the unemployment office. Fed policy can feed some sectors but right now what we need is stronger balanced growth.
The President said he wants to grow from the middle out. I seem to have no trouble growing from the middle out but that’s a different thing. If he wants balanced growth then I am on his side. Balanced growth means, I think, that we pay attention to our real problems. And we have plenty of them. But the difficulty is that we have a government that doesn’t work. These guys and gals can’t even agree on how many Martinis to have for lunch. So why list again all those problems. Those yokels are not going to solve them anyway.
So that’s the basis of well-deserved paranoia. There is a way to put out a grease fire. But it takes a metal lid, baking soda, fire extinguisher, etc. If you do not have any of that stuff, then it makes absolutely no sense to pour water on the fire. It just makes it worse. That’s our situation in the US. Money has no remedial power for our current problems yet since the government has abdicated its role we keep asking the Fed to pour water on the flames.
But there is still this lingering question – Davidson if you are right then why aren’t you rich? The stock market blessed the Fed’s decision to put off tapering. Those people thought it was a good move. My only answer is that the stock market is only one response to the Fed’s actions…and a few days of changes are hardly evidence of anything. Investors have benefited from a stock market that has recovered and is now entering new record high values. Who can blame investors for responding positively to more of the same? But what about the thousands of business organizations that are not doing the wave right now? After the QE bonanza why are banks still sitting on hoards of excess reserves? Why are firms reluctant to borrow? Why are workers dropping out of the labor force? Those actions speak louder than one day’s change in the Dow Average. Those behaviors are crying for a non-monetary appropriate solution.
Okay so maybe extending the current Fed policy is not helping but won’t tapering be too much for the economy to take now? I don’t think so. If you take away something that doesn’t add anything how can that lead to a subtraction? Taking away QE does not mean the Fed cannot increase the money supply. But QE is adding almost a trillion dollars of reserves each year. Even if the economy was growing at 5% it would not need that much more money each year.
In the 10 years from 1998 to 2007, the average increase in the US money supply (the version called M1) was $30 billion per year. The highest annual increase of $77 billion was in 2003. In 2012 the US money supply increased by $301 billion. We injected in 2012 more than 10 times the amount of money we usually need in one year – and we did that after increasing the money supply by $267 billion in 2011. It looks like 2013 will find another huge dose. This stuff does not disappear. It accumulates. We have enough money out there to support economic growth for about 30 years! We don't need more money -- we need bankers who want to lend it and firms who want to borrow it!
Tapering will not cut off liquidity in the US economy! I can’t be sure how the markets will react right after an announcement to taper, but I will bet a week’s supply of JD that after the initial reactions we will find ourselves with another Y2K…much ado over nothing. Get on with the tapering Ben and Janet.