As one juices the bull, one is also forced to wade through the bovine excrement. Someday we’ll look back and wonder how insane this all was. Some people in this world still believe in financial alchemy.
From the WSJ:
It’s Ben Bernanke’s economy, and everyone else is along for the ride.
That reality has been clearer than ever in recent days, as financial markets lurch while awaiting the Federal Reserve Chairman’s next monetary intimation, and now with President Obama’s Monday hint that he may not reappoint Mr. Bernanke to another four-year term.
The recent market turmoil follows Mr. Bernanke’s suggestion to Congress last month that the Fed could start reducing its $85 billion in monthly bond purchases later this year if growth is strong enough. There’s a lot of wiggle room in “could,” but the market reaction has nonetheless been sharp. The 2013 rally in stocks took a pause, bond yields have climbed, and capital has flowed out of emerging markets. All of this reverses what happened when Mr. Bernanke announced his open-ended bond buying last year.
This is a portent of what is likely to be continuing ferment when the Fed finally unwinds its extraordinary monetary interventions. The biggest question about the Fed’s policy of near-zero interest rates and unlimited quantitative easing has always been: What happens when the music stops?
Mr. Bernanke’s answer is that the Fed has the “tools” to unwind, and it will use them when the economy is healthy enough. The Fed says this means a jobless rate of 6.5% or lower (from 7.6% today) and presumably a durable housing recovery. With some “open-mouth operations” to signal its intentions, the Fed thinks it can manage a gradual adjustment that avoids inflation or bursting asset bubbles. We all wish it will be so.
But as the central-banking proverb holds, it is easier to get on the bull than to get off. The eternal problems are timing and political will. Knowing when to get off is hard enough when the only major variable is the traditional fed funds rate. It is harder still when the variables include a promise of near-zero rates into mid-2015 and a Fed balance sheet that has nearly quadrupled in five and a half years to $3.4 trillion.
A crowd will always form in Washington and on Wall Street to say it’s too soon to stop, and those voices are already urging the Fed not to signal any reduction in bond buying at this week’s Open Market Committee meeting. They say there may be a housing recovery, but it isn’t solid enough. The jobless rate is falling, but not fast enough. And with little sign of inflation (0.1% in May, 1.4% over the past year), we’re told that any reduction in purchases runs the risk of falling prices.
The deflation fear can be especially beguiling, as Mr. Bernanke knows. In 2003 Fed Chairman Alan Greenspan and a certain new Fed Governor named Ben Bernanke cited deflation risks to justify holding the fed funds rate at 1% for an entire year even as the economy was accelerating to a nearly 4% growth rate. This was the original sin that did so much to produce the housing bubble and financial panic.
Our view is that the sooner the Fed begins to unwind, the better. Its interventions were necessary amid panic and recession in 2008-2009. But the recovery reached its fourth anniversary this month. And while growth remains subpar, it isn’t clear that monetary policy can do more to increase it.
The Fed can’t repeal ObamaCare, which is a deadweight burden on job creation. It can’t repeal the tax increases that hit in January, notably on small businesses. And it can’t repeal the waves of new regulation that the Obama Administration continues to impose across the economy. The miracle is that growth is as strong as it is, which speaks to the private innovation that continues to take place in energy, biotech, digital devices, big data and more.
Meanwhile, the longer QE and near-zero rates continue, the more risks accumulate. The longer investors scramble for yield, the greater the risks of misallocated capital and bubbles we may not see until it is too late. Savers have been punished for a half decade already, while low-interest rates have made it easier for politicians to spend with too little consequence.
Which brings us to Mr. Bernanke’s future when his second term expires in 2014. Mr. Obama told Charlie Rose of PBS on Monday that the Fed chief “has already stayed a lot longer than he wanted or he was supposed to.” This suggests that Mr. Obama may prefer to name a new Chairman, and the pressure within his party is great to choose Fed Governor and economist Janet Yellen. She would be the first woman Fed chief and is known to favor even more expansionary monetary policy than Mr. Bernanke does.
The political virtue of choosing Ms. Yellen is that Mr. Obama would have a loyalist in the job and thus no ability to dodge responsibility if the Fed gets it wrong. On the other hand, Mr. Bernanke made the decision to hop on this bull and ride it for more than four years. There would be rough justice in seeing if he really can manage a smooth dismount.