Opinion

The Great Debate

Fed tightening will help stem inequality

By Alexander Friedman
May 12, 2014

The Federal Reserve Building is reflected on a car in Washington September 16, 2008. REUTERS/Jim Young

Just as quantitative easing by the U.S. Federal Reserve has inadvertently increased the country’s wealth gap, so should tapering limit its rise.

Under the central bank’s program of pumping money into the economy, purchases of financial assets have enriched the 10 percent of Americans who hold four-fifths of the country’s stocks and bonds. With the Fed’s liquidity being withdrawn, the whole effect should be more muted. And absent such underpinning for equities, corporate executives will be much more likely to invest to improve returns. This should involve more hiring and a better outlook for those outside the top decile.

Since the start of quantitative easing (where the Fed created more money), the price investors were prepared to pay for corporate earnings rose from very low levels during the financial crisis to fair levels today.

As the Fed slowly withdraws, earnings growth, rather than the price paid for those earnings, should be the main driver of stock returns. With profits likely to increase at a higher single-digit rate, stocks should rise at the same rate as well. The big returns of 2013, and their huge effect on the net worth of the wealthy, are unlikely to repeat in the near term.

If the outlook for the wealthy moderates, forecasts for those in the lower echelons of income should improve as prospects for private-sector employment pick up.

Until the Fed taper began, all else being equal, the average U.S. company could rely on easy monetary policy to push up its share price. Now that the Fed is due to end quantitative easing and move closer to raising interest rates, U.S. companies will have to embark on capital expenditures and job-creating investments to boost their returns. Ironically, tighter Fed policy may do more to boost employment and hence equality than the ultra-loose regime that has preceded it.

U.S. companies have plenty of money to put to work. Non-financial corporations hold more than 10 percent of GDP in cash, close to an all-time high. Yet net investment is running at just 4 percent of GDP, from levels almost double that at the turn of the millennium. With public investment recently seen at its lowest percentage of output since 1947, the government is scarcely crowding out private capital.

As the U.S. recovery continues, there is ample room for companies to move money out of deposit accounts, where interest rates remain ultra-low, and invest it in job-creating projects with a higher yield. For those outside the top decile seeking employment, or the prospect of better jobs, such investment would provide a much-needed boost.

When deploying their spare cash, U.S. companies have a number of alternatives to job-creating investment, including share buybacks and mergers. The attractiveness of both of those options is waning, however, as equity markets break new highs. On a net basis, for example, companies in the S&P 500 Index already bought back shares worth 2.1 percent of their market value in 2012 and 2.3 percent in 2013.

Corporations have admittedly been spending more on M&A; activity was up 5 percent last year, according to Dealogic, and the prospects in sectors like pharmaceuticals have proved significant in 2014. Unless an acquisition unlocks significant synergies between companies, however, corporate stock is not as cheap an investment as it used to be. Hiring workers to exploit open investment opportunities will often prove more profitable.

Overall, far from dampening the U.S. recovery, the end of QE should support it. It should also leave the bottom 90 percent less dependent on trickle-down economics.

Former U.S. President Ronald Reagan, the most notable proponent of such policies, said the most terrifying words in the English language were “I’m from the government, and I’m here to help.” Had the nation’s central bank failed to signal a shift away from ultra-loose monetary policy, some may have started to feel similarly about the Fed. When it sees the likely benefits for equality and jobs, the United States should start to appreciate tighter monetary policy, not fear it.

PHOTO: The Federal Reserve Building is reflected on a car in Washington September 16, 2008. REUTERS/Jim Young

Comments
8 comments so far | RSS Comments RSS

A feeble attempt to give the other than ultra wealthy hope for the future. The 1%’s scramble to accumulate more and more wealth is irreversible except by the inevitable radical re-engineering of the whole system.

Posted by miragekiller | Report as abusive
 

This article is full of lies. Notice that the authors are two investment bankers, and work for one of the sleazier banks – UBS. The top 1% (by income) want the Fed to taper in order to protect the paper gains from the previous five years. The 1% have taken profits on most of their stocks, so now they are urging the Fed to taper. They feebly argue that tapering will help the little people (the 90%). No! If the fed tapers now, then we will be just like Japan 20 years ago – Corporations will not invest – they will retrench and lay off people. There will be another recession and the 1% will wait for the market to crater again and then buy stocks again. To support job growth now, the Fed must loosen policy. Bernanke rightly said that the lesson of Japan is NOT to tighten too quickly.

Posted by teppie | Report as abusive
 

I’d be interested in understanding an explanation of the big increase in income inequality in the years pre-QE. There must have been some other government-initiated program that if removed would allow the free market to fix everything.

Reminds me of Milton Friedman’s idea that we didn’t need laws to fight racism because the “invisible hand” would take care of it – something about how racism made no economic sense and would therefore be extinguished by the power of the free market to drive rational behavior.

Now, you can expect more rational behavior from business executives thinking about money than from the general population thinking about people that look different, but without a clear ROI, they don’t invest, and you don’t “add jobs” if you can’t sell the products they produce. Show a path to a good return and you will get job-creating investment.

Posted by lkrohn | Report as abusive
 

How about we get rid of the Fed. Their policies have been helping their criminal banking friends and hurting the rest of us. They’re parasitic and we’d be better off without them.

Posted by Yvo_Kerwar | Report as abusive
 

I strongly disagree. The rich and their investment bankers want to protect their gains from the last five years and so they want the Fed to taper before inflation ramps up. The rich are taking their profits right now, and the economy will be right back in recession by the time the taper is complete. There will be no massive hiring, but the rich do not need jobs so they do not care. As Bernanke said, the biggest danger is to tighten too soon – that is the lesson to take from Japan. We will go right back into recession and then an even bigger stimulus will be required later (see Japan now).

Posted by teppie | Report as abusive
 

Paid content Reuters?

Posted by tmc | Report as abusive
 

Funny stuff! After giving the 1% 30 years of trickle down, voodoo economic gains the new normal is the GOP feed the rich and starve the poor and middle class approach. Poor mega wealthy will see interest rates go up a bit and will have to hide wealth in less obvious locals. As interest rates increase, the price of homes will decrease leading the working poor and middle class with less. While interest rates increase, the charges that the working poor and middle class pay on debt, including student loans, will increase, leaving people with less. The wealthy will hide their Fed and congressional assigned wealth in treasuries that will pay them more! Your assumption is foolish at best and clueless at worst. CEO pay is hundreds of times that of workers, tax laws favor the wealthy, congressional approved job outsourcing favors the wealthy, GOP fight to stop an minimum wage increase for God’s sake! GOP cut food aid to hungry kids and end unemployment benefits to millions of long-term unemployed and 280,000 veterans. A minor change in fed policy will not help any of those people. Get your head out of the 1% darkness, your ivory tower and your cordoned campus and look around if you dare.

Posted by layofflist | Report as abusive
 

Huh…So what you are saying is- if the landlord reduces your rent then you are free to spend on other things…

Posted by ex-fungi | Report as abusive
 

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