There will soon be a changing of the guard at the U.S. Federal Reserve as Ben Bernanke hands the reins (together with the paper, ink and printing press) over to Janet Yellen. Regarded as a ‘dove’ rather than a ‘hawk’ (i.e. she is more concerned with unemployment than inflation) it is highly unlikely there will be any change to the Fed’s current monthly Quantitative Easing (QE) addiction, whereby $85bn is created to purchase a mixture of government debt and mortgage backed securities.
Bernanke’s behaviour over recent months has not made her job any easier. Back in May, he indicated that QE might soon be subject to a degree of ‘tapering’. This should not be confused with a reversal or even abandonment of QE; it simply means a reduction in the current rate of asset purchases. As such, there would be no sale of securities and subsequent recapturing of any ‘printed’ money. If Bernanke was angling to see how markets would react, he got a quick response as major indices soon posted double digit percentage losses. Soothing comments rapidly ensued making it clear that by keeping interest rates at historic (and artificial) lows, the needle would stay in the patient’s arm for as long as was considered necessary. That message has recently been reinforced but by losing its nerve, the Fed has let the cat out of the bag; it obviously doesn’t believe the economy is strong enough to sustain itself and if it is persistently to seek the approval of the markets, then the answer will be the same every time.
Which neatly encapsulates the Fed’s dilemma. Just how does it engineer an orderly exit from this gigantic economic experiment? By being the buyer of last resort it has created so much money to buy so many assets that when it eventually opens the shop, a vista of windblown tumbleweed is more likely than a crowd of customers. And even the dumbest economists (you know, the types that advise governments and work for the IMF) might be able to work out that when almost infinite supply meets almost no demand, the result will not be good.
I say ‘might’ with good reason. Laughably, the U.S. Treasury recently criticised Germany for the size of its current account surplus. Furthermore, European Commission President, José Manuel Barroso, has launched an inquiry into whether this surplus is harming the European economy. “We would like to have more Germanys in Europe”, said Barroso, without a hint of irony. He is correct to launch an investigation but instead of probing Germany’s surplus, it would have been more sensible to ask why the majority of the Eurozone post persistent deficits. But then, if you don’t understand the problem, you’re unlikely to ask the correct question.
Academics like Bernanke, Yellen, Barroso et al live in a world of their own making. Not for the first time I’m reminded of veteran Wall Street fund manager Peter Lynch’s maxim that “if all the economists in the world were laid end to end, it wouldn’t be a bad thing.”
John Newsome can be contacted on: 01423 705123 or email:john.newsome@williams-im.com
