Opinion

James Saft

Fed hits its 3rd mandate: rising shares

January 18, 2011

James Saft is a Reuters columnist. The opinions expressed are his own.

Apparently not satisfied with being unable to fulfill its dual target of price stability and maximum employment the Federal Reserve has set itself a third mandate: higher asset prices.

Speaking on CNBC at a Federal Deposit Insurance Corporation-sponsored forum on small business lending last week, Fed Chairman Ben Bernanke was asked how, in essence, his $600 billion quantitative easing programme could be called a success when interest rates and commodity prices had actually risen in response.

“We see the economy strengthening, its gotten better over the last three or four months, a 3-4 percent growth number for 2011 seems reasonable,” he said.

“Our policies have contributed to a stronger stock market, just as they did in March of 2009, when we did the last iteration (of quantitative easing). The S&P 500 is up about 20 percent plus and the Russell 2000 is up 30 pct plus.”

So, there you have it; the man who controls the printing presses congratulating himself for driving stock prices higher.

First off, this is a very low hurdle of success. It is a bit like playing battleships in the bathtub and calling yourself a great admiral for pulling the enemies’ ships under the water.

We know he can do it — as he says he has done it in the past. The question is: should he?

The theory is that higher asset prices, particularly rising asset prices, will help to restore confidence and will entice greater investment and consumption.

Consumers, feeling a bit richer, will spend a bit more, and businesses will respond by committing to investment in new capacity to meet new demand.

Money parked on the sidelines will go from feeling smart to feeling stupid and will move into riskier assets like stocks or high yield bonds.

On this analysis, Bernanke and his supporters on the Federal Reserve are exactly right, some of the money that is summoned from the ether by rising stock prices will be spent and that once notional cash will have a real impact.

But really, how well did this work out the last couple of times it was tried, first in the 1990s and then again in the last decade? Not well.

Many Americans committed to spending programs that their earning power really wouldn’t support and huge and insupportable debts were created in the process. The dotcom and housing bubbles were produced and duly burst, and each successive bubble dealt deeper damage to the financial system and global economy.

KEEPING IT SIMPLE

While we have known for months that the Fed was targeting asset prices with QE, it really is shocking to hear it enunciated so clearly.

As money manager John Mauldin mused in a letter to clients, would the Fed be setting targets for shares? Were there other assets it would like to target?

The Federal Reserve is deeply compromised by doing this; it is two thirds of the way down a slippery slope and the mud is starting to fall from above.

The policy may not work and may have considerable unintended consequences, as hinted at by Philadelphia Fed President Charles Plosser in a speech on Monday.

“The notion persists that activist monetary policy can help stabilize the macroeconomy against a wide array of shocks, such as a sharp rise in the price of oil or a sharp drop in the price of housing. In my view, monetary policy’s ability to neutralize the real economic consequences of such shocks is actually quite limited …

Attempts to stabilize the economy will, more likely than not, end up providing stimulus when none is needed, or vice versa. It also risks distorting price signals and thus resource allocations, adding to instability. So asking monetary policy to do what it cannot do with aggressive attempts at stabilization can actually increase economic instability rather than reduce it,” Plosser said.

Perhaps even more disturbing is the idea that the Fed’s bathtub play with stocks and shares opens it up to outside pressure which could fundamentally undermine both its reputation and independence.

As was the case with its decision to direct capital to specific sectors of the economy, bubbling asset prices will be viewed by people like new Congressional Monetary Policy subcommittee Chair Ron Paul as an infringement of Congress’ traditional control of the purse strings.

When it comes to purchasing securities the line between fiscal and monetary policy becomes all but meaningless, and so the Fed’s action is a counterweight to inaction by Congress and the Executive branch.

More stimulus may well be what the economy needs, but if true it needs it from the fiscal side rather than by encouraging more share holders to spend more money they haven’t really got.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund.)

Comments
17 comments so far | RSS Comments RSS

Just who is the Fed and why should we satisfy their demands. I know who the Fed is, a bunch of international fat cat bankers and industrialist that enslave our economy. They are no more a part of our government than Fed-Ex. We should send them packing ASAP.

Posted by MBrewer | Report as abusive
 

I thought that asset prices were bubbly in early 2010. I sold my equity positions in the winter/spring. Silly me….I never thought that Mr. B would prop up assets with “QE2″.

I’ve since liquidated my bond positions(in late 2010) as the continuing rise in commodity prices has me worried about inflation. This situation seems to be getting worse as “QE2″ continues.

So, I’m getting about 1 to 1 1/4% on my money spread around at credit unions and banks.

Boy, do I feel stupid!

Funny thing though, I felt “stupid” in 2007 when I sold (what was at that time) a large portion of my stock holdings. I did this because I couldn’t make any sense of the markets. I always seem to be about 6 – 12 months early.

Oh well….I’ll just have to wait this one out to see if I’m stupid or sane.

One thing is for sure, I’d rather feel stupid and sleep well. I won’t be buying any time soon.

MIA

Posted by Missinginaction | Report as abusive
 

All that QE2, QE3 and so on can do is merely raise Asset prices. Only a fool would think that it can generate employment or make America competitive. Bubble and Bust is going to be the theme for this decade. As to how all the Government Debt will be repaid, no one has any ideas. The philosophy is fairly simple – make hay while the Sun shines, however make sure you exit the party well before the bill comes due.

Posted by goldchest | Report as abusive
 

Mr. B, you know hyper inflation is on its way. Quit playing the shell game and tell the truth. We are about to see an implosion like none other and it will bring down the entire world financial markets. China, get ready to foreclose on America.

Posted by minuteman | Report as abusive
 

Forgive me for being cynical. I can’t even give QE2 credit for being cunning after the results of QE1 and the bailouts. Rising share prices as a positive outcome seems to be a canard to me. Where is the “substance”? Are any “positive outcomes” quantifiable apart from rising share prices? Hundreds of billions of dollars in QE1 and related bailouts!! Are there any metrics to show how stated objectives were achieved? One metric that was paraded around was that 2 million jobs would be created by QE1 and the bailouts. Has anyone stated how many jobs were created or saved? Wouldn’t this kind of press be the best copy for proponents of QE1 and the bailouts? Not only do I hear nothing about results from QE1; I hear no criticism, either. Very baffling to me – am I missing something? Now QE2 for $600 billion says it will create 3 million jobs. This seems like $200,000 per job – very elementary math that I am sure is inadequate. Except, are there any statistical models being offered showing how the $600 billion of QE2 leads to created jobs in XYZ scenarios coupled with how statistically likely/significant those various scenarios are? We just have bold, media headline talking points. Again, where is the substance behind the claims? What is the analytical justification? Why do I think the bulk of the money committed to QE1 and the bailouts went into the pockets of a select group of financial industry conglomerates? Could it be the fiscal results they posted in 2009? Now, QE2….

Posted by Denorien | Report as abusive
 

Like Greenspan, Bernanke is a student of the Great Depression and terrified of a deflationary collapse the Central Bank is powerless to prevent or reverse. Read his speeches from over the years and you will see that he has always been prepared to print an unlimited quantity of paper to “save” the world. Remember “Helicopter Ben”.

Bernanke has been at this for three years now and the result has been predictable: higher financial asset prices — along with $1,400 gold, $100 oil, and riots in the developing world as inflation in agricultural commodities makes food unaffordable for millions of people.

The Federal Reserve was created to be independent from government to make it less likely it would succumb to political pressure to inflate but even learned men will throw caution to the wind when faced with a crisis; Bernanke has proven that.

Just as higher inflation was easily predicted, so too, can we be certain of the ugly aftermath. Welcome to America, circa 1977 — or will it be Germany, circa 1922?

Posted by StevenFeldman | Report as abusive
 

Higher asset prices…

Right…

No additional value behind them, just higher prices…

Isn’t that called a “Bubble”?

Isn’t that what caused the Dot Com bust?

Oh, and the bust of the housing market?

And isn’t rasing prices just to raise prices a great way to initiate a loop of hyper-inflation?

This guy needs to be removed from office and dropped on a remote island in the middle of the AntArtic with no communication gear.

He could definitely use a thicker atmosphere with mre oxygen in it and it would also prevent him from doing more damage.

Posted by bobw111 | Report as abusive
 

Intersting how an extreme editorial collects even more extreme comments.

The Fed’s actions to date can just as easily be interpreted as a once in a lifetime response to a once in a lifetime crisis. Certainly anyone who reads the Fed’s balnce sheet, published weekely post close on Thurdays, know that “Helicopter Ben” has been doing anything but that. The Fed’s balance sheet has shown minimal growth since the initial bulge of October 2008. Every new program of stimulus has been funded by the lapse of a prior one.

We all understand the inflationary danger of “printed money”. Please, idealogue and Paulist goldbugs,note that there hasn’t been much printing lately.

Posted by treadonthee | Report as abusive
 

Probably taken out of context. To drive stock prices up has no value as historical P/E’s have always been the same in valuating companies for the last several hundred years. If the average P/E for a partiuclar rate of growth is mismatched it always falls back. Traders may make money but long term investors will just watch it fall back.

Posted by John2244 | Report as abusive
 

Hmmmm,

Everyone is missing the obvious here. Bernanke is printing money and buying US T-bills because no one else is. About 20 percent of our debt is in 1-2 year T-bills, Clinton had 20-30 year T-bills issued , Bush had 10-5 year T-bills issued.

We are having a lot of US debt come due in the near future almost all of it and a lot of people are not rolling the money over. So just where is all of this debt money going to come from. The answer is the Federal Reserve. If they would open up their books you will find they are holding onto about half the US debt off balance sheet.

The only thing keeping the US economy from total collapse is the same reason we were afraid of a total collapse of the Soviet Union. They had nuclear weapons and the world let them collapse slowly. Same is happening to us. Why do you think we have 9.4 percent unemployment and real unemployment over 20 percent???

Everyone wants to trash the US economy so we become less and less powerful and everyone is trying to get the US and Russia to get rid of their nuclear weapons. The question becomes what happens while the US is being down graded to third world status.

Posted by JEYF | Report as abusive
 

Is anybody as embarrassed by Mr. Hu’s visit as I am? The imagery tells it all. Mr. Hu, the conservative keen-eyed Republican landlord, coming to check up on his debtor tenants, the U.S. president and vice president, the Democrats. I feel so ashamed.

Posted by bnimocks | Report as abusive
 

Who wrote this? A child?

“”this is a very low hurdle of success. It is a bit like playing battleships in the bathtub and calling yourself a great admiral for pulling the enemies’ ships under the water.”"

Do you remember the despair of March, 2009?

Posted by BudH | Report as abusive
 

The inflation is in fact well-timed. Not hyperinflation or imported inflation though and the author is absolutely right that stability is a central bank’s number one worry. But normal inflation makes companies run, it clears the old debt (new debt will be more expensive however), and it stimulates people to consume and/or to take risks again. Not unimportant is that structure banks are forced to give out loans again. In general, it’s a whole lot better then the possible deflation that we were facing the last years. Japan can tell you all about it.

Posted by FBreughel1 | Report as abusive
 

This excellent James Saft article, along with the great reader comments, is pure vintage Reuters. This is what keeps me coming back to Reuters for news. Thanks to all.

Posted by AdamSmith | Report as abusive
 

I can’t even give QE2 credit for being cunning after the results of QE1 and the bailouts. Rising share prices as a positive outcome seems to be a canard to me. Where is the “substance”? Are any “positive outcomes” quantifiable apart from rising share prices? Hundreds of billions of dollars in QE1 and related bailouts!! Are there any metrics to show how stated objectives were achieved by QE1 and the bailouts? One metric that was paraded around was that 2 million jobs would be created by QE1 and the bailouts. Has anyone stated how many jobs were actually created or saved? Now QE2 for $600 billion says it will create 3 million jobs. This seems like $200,000 per job – very elementary math that I am sure is inadequate. Except, are there any statistical models being offered showing how the $600 billion of QE2 leads to created jobs in which scenarios coupled with how statistically likely/significant those various scenarios are? Why do I think the bulk of the money committed to QE1 and the bailouts went into the pockets of a select group of financial industry conglomerates? Could it be the fiscal results they posted in 2009?

Posted by Denorien | Report as abusive
 

Rising share prices as a positive outcome seems to be a canard to me. Are any “positive outcomes” quantifiable apart from rising share prices? Are there any metrics to show how stated objectives were achieved by QE1 and the bailouts? One metric that was paraded around by QE1 was that 2 million jobs would be created. Has anyone stated how many jobs were actually created or saved by QE1? Now QE2 for $600 billion says it will create 3 million jobs. This seems like $200,000 per job. Except, are there any statistical models being offered showing how the $600 billion of QE2 leads to created jobs? Why do I think the bulk of the money committed to QE1 and the bailouts went into the pockets of a select group of financial industry conglomerates? Could it be the fiscal results they posted in 2009?

Posted by Denorien | Report as abusive
 

Fed is like a clown in a circus. They have to fulfill their duties regardless of what they think is right. They cannot tell the truth, no matter what, or confidence will crumble. No inflation? That statement is an insult to every human on the planet.

http://precisiontradingsolutions.blogspo t.com

Posted by precisiontrade | Report as abusive
 

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