Fed: Stop the presses
On Thursday, the Bank of England said that it would run its printing press a bit faster while the European Central Bank hinted that theirs might slow down sooner than expected.
In the United States, the Federal Reserve’s printing press is running low on ink, and Ben Bernanke has his own choice to make: Buy a new cartridge or shut the thing down. He should shut it down.
In particular, I’m referring to the Fed chairman’s commitment to print $300 billion to buy Treasury bonds by the end of September.
So far the Fed has purchased $243 billion since the program began in March. He’s on schedule to hit the $300 billion mark next month, right on schedule. The question is whether he should buy more. (Click table to enlarge in new window)
With some signs pointing to a recovery, the conventional wisdom is that the Fed can let the program expire. That’s right, but for the wrong reasons.
The problem with quantitative easing, and with all programs fiscal and monetary intended to artificially support asset prices, is that they badly distort markets, preventing them from grappling with the underlying problem of leverage.
They also send false signals to market participants that it’s safe to take risk.
Leverage is still at record highs. To take just one measure, according to the Fed’s first quarter flow of funds report, total credit market debt to GDP stood at 376 percent. (Click chart to enlarge in new window, ht Comstock Partners)
We’ve run up more debt that we can possibly pay. As any overextended borrower can tell you, the way to deal with excessive debt is to pay it down, or declare bankruptcy.
But quantitative easing encourages people to take on more debt.
Take homes, for instance. Mortgage rates are tied to Treasury rates, which are held artificially low thanks to the Fed. Low mortgage rates lead to higher house prices and higher house prices provide collateral to take on more debt.
But when the Fed’s artificial support is removed, prices will continue their march downward and borrowers will find they can’t pay off their last loan.
Every time we hit a recession, the Fed’s solution is to hit the gas, encouraging folks to go deeper into debt. For a time, credit expansion provides the illusion of economic expansion. Until, that is, inflation fears force the Fed to hit the brakes.
We’re addicted to debt. But instead of trying to kick the habit, we invent ever more creative ways to find our next fix.
Once upon a time, low interest rates were enough. Not anymore. So the Fed devised a dangerous combination of zero interest rates and quantitative easing.
Before we were snorting the junk. Now we’re injecting it. And the high is causing market participants to take more dangerous risks than they should.
People jumping back into the housing market are in for a rude awakening as prices continue to fall and their equity evaporates. If house prices trend back up, it won’t be because people can pay more, it will be because credit markets have loosened up again and they can borrow more.
Then we’re back where we started, but with an even larger pile of unpayable debt.
The economy won’t be on a sound footing until debt levels fall, and that won’t happen as long as the Fed stands in the way. It should let its three quantitative easing programs expire on schedule, and make a firm commitment that they’re not coming back.