Fed hits its 3rd mandate: rising shares
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.)