by Don Gould
Like Pavlov’s famous dog, the markets now seem conditioned to lurch upward every time Fed Chairman Ben Bernanke rings his easy money bell. (A similar story could be written about the European Central Bank and its chairman, Mario Draghi.) I find this persistently disturbing, like a recurring bad dream waiting to become a reality.
Big Ben has printed roughly two trillion dollars in the last four years and, in an experiment without precedent, has used them to buy financial assets – mostly US Treasurys and mortgages. The polite term for all this money creation is “Quantitative Easing,” or QE for short. In the process, the Fed has driven short-term US interest rates to near zero, and through its “Operation Twist” (which sounds vaguely like the title of a late 1950s madcap movie that might have starred Fred MacMurray) has managed to push even the longest term rates below 3%. (As an aside, the Fed effectively purchased 60% of all net Treasury issuance in 2011. Remind you of any southern European countries?)
With Bernanke’s latest announcement of QE3, we learned that the Fed will print another $500 billion annually, potentially indefinitely. Additionally, Operation Twist will remain in full force, and short-term interest rates will be kept near zero for at least another three years.
The thinking seems to go, if we can just print some more money, everything will be hunky dory, or at least a little less grim. In essence, the theory says that by printing money, we can print wealth, too. If 2 trillion is good, why not print 20 trillion? More formally, the Fed argues that these very low interest rates have helped the economy to the tune of 2 million extra jobs. How, you ask? A couple of ways, apparently.
First, low interest rates have reduced borrowers’ interest expense, leaving them more money to invest in job-producing activities, and perhaps also stimulating the moribund housing industry. And second, low interest rates have pushed the stock market higher, creating a so-called “wealth effect” whereby the owners of the appreciated stocks are thought to be a bit looser with their purse strings. At the margin, their extra spending stimulates the economy and also translates into more jobs. Count me among the skeptical.
Surely the Fed’s policies have also engendered a reverse wealth effect. Just ask any retiree trying to live off the interest from their bonds and CDs. We estimate that annual interest income from a typical bond portfolio has dropped by perhaps 40% in the last four years and will continue its descent as the proceeds from maturing bonds are reinvested at today’s minuscule interest rates.
The typical south Florida retiree is less worried about hurricanes than the government’s wholesale plundering of a kind of social contract – one that said that if you worked hard for decades and were thrifty enough to accumulate, say, $1 million, you could comfortably live out your retirement years on the interest from your bank CDs. 5% interest would get you $50K per year. Now it’s maybe 15K. And shrinking.
How anyone could think that more money printing will help us now, given that interest rates are already scraping their lower bound, is beyond me. Our college economics texts called this the “liquidity trap,” cleverly described as pushing on a string.
As for the Fed policy that seeks to create a wealth effect, we might restate it this way. If the Fed can keep interest rates low enough, long enough, bonds and CDs become so unattractive that stocks look good by comparison. Desperate for income (even the S&P 500’s 2% dividend yield looks good by comparison) and at least a theoretical possibility of a decent total return, investors will say a prayer and throw cash at the stock market. In the process, many could easily be building portfolios that are riskier than they can actually tolerate over time.
I have a strong visceral negative reaction to the idea that the government is printing money to drive the stock market higher. Yet the Fed openly acknowledges such a policy (see Bernanke’s August 2012 speech at Jackson Hole) and even trumpets the rising stock market as one of its triumphs.
Lest I give the wrong impression, no one should blame Ben Bernanke for today’s problems. I have considerable sympathy for Bernanke. We’ve asked him to dance the tango solo. The real changes needed today must come from the House, Senate and Executive branch in Washington. With his dancing partner missing in action, our nation turns its lonely eyes to Ben, and he does what he can, printing more money on the off-chance it might do just a little good.
Yes, low interest rates have pushed up the stock market. But here’s another take worth considering. Maybe all this money printing is driving cash into anything that might protect one from debasement of the currency. That includes not just stocks, but also gold, commodities, real estate and anything else that can’t be created with the stroke of a pen. In other words, printing money is inflationary after all. It’s just that today’s inflation expresses itself more in the price of assets, rather than goods and services. The other inflation – consumer price inflation – probably lurks somewhere down the road, on top of a multi-trillion dollar pile of dry tinder.