The taper: let’s not call a retreat a victory – James Saft
By James Saft
(Reuters) – If the Federal Reserve does begin to taper its purchases of bonds in September there is really only one way to interpret the move: as a retreat.
Not a victory, because, as can be seen most clearly in last Friday’s U.S. July labor report, the employment market is not strong, not creating high-quality jobs, and wages are actually falling. If your dream is to flip burgers to pay off your education debt, this is your economy.
Certainly not a victory, because, despite the undoubted stimulus of low rates, the most important measure of core inflation is well below the Fed’s comfort zone and trending lower.
The strong arguments for starting to taper purchases of mortgage and government bonds are all about costs and risks. Bond buying works by distorting prices, blunting the already addled risk sensors of financial markets and leading to a sizable, and ultimately costly, misallocation of capital.
In its own sweetly indirect way, the Fed has been upfront about this, as can be seen in the statement released last week along with its decision to keep current monetary policy in place:
“In determining the size, pace, and composition of its asset purchases, the Committee will continue to take appropriate account of the likely efficacy and costs of such purchases as well as the extent of progress toward its economic objectives.”
Like most complex financial strategies, the efficacy has been questionable and the costs all too real.
Now it is possible, just, to make a case that the economy is making progress toward the Fed’s employment goal. After all, unemployment fell to 7.4 percent last month from 7.6 percent, and may well hit, perhaps early next year, the 7 percent rate seen as a flag for ending bond purchases. Unfortunately, the fall in unemployment owes a good deal to demographics, as large numbers of people age out of the work force every month. As Japan shows, an aging population and persistent low growth and inflation can easily go hand in hand.
And if we consider the quality of the jobs being created in the recovery, there is less reason yet to declare victory and go home. Fully 65 percent of the jobs created in July were part time, while more than half came from the low-paying retail, restaurant and bar sector.
Wait, I hear you say, how can it be fair to hold monetary policy responsible for low-quality job creation?
Exactly. In the absence of an irrational panic by employers and businesses, monetary policy can do very little to create better jobs. Government does have levers it can pull to help that happen, but none of them have much to do with the prevailing interest rate, much less with how rapidly the stock market ascends.
In fact, the example of the last bubble is instructive. The housing boom created many high-paying jobs, a lot of them the kind you can do without a college degree. Unfortunately the demand for those houses, partly created by very low interest rates, was false. In the end, much economic damage was done by capital and labor being pulled into housing only to be unceremoniously dumped later.
And that kind of risk is exactly the reason we might want to consider a taper a good thing. Financial markets, which exist because they help to direct money where it can best be used, have come to rely on financial intervention from the Federal Reserve to constantly backstop the errors risk-takers make in hopes of private gains.
“Some have come to expect the Fed to keep the markets levitating indefinitely. This distorts the pricing of financial assets, encourages lazy analysis and can set the groundwork for serious misallocation of capital,” Richard Fisher, president of the Dallas Federal Reserve, said in a speech on Monday.
A taper would not only be a welcome reminder that in investment not every kid goes home with a medal, it would also, perhaps, help to reverse the distortions we can now see building up again in the housing market.
As Fisher points out, the Fed now owns $1 out of every $5 of Treasury notes and bonds currently in existence, and buys more than a quarter of all new bonds as they are issued. When it comes to mortgage debt, the gorilla that is the Fed weighs in at a bit more than the proverbial 800 pounds: owning a quarter of all outstanding mortgage-backed securities and buying more every month than the market actually creates net of those which mature or are redeemed.
A taper in September will be painful, and as such is by no means a sure thing.
If it happens, let’s be honest about why.
(At the time of publication, Reuters columnist 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. For previous columns by James Saft, click on)