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REMINDER: All investment, economics, and finance related material now appears at the new IaconoResearch.com. For the time being at least, this has become a personal blog covering a variety of mostly unrelated topics.
With short-term interest rates pegged to the floorboard since late-2008, the Federal Reserve’s balance sheet is what people now watch to see what the central bank is up to, and it has changed considerably over the last two years as shown below.
Look for that pink area – U.S. Treasuries – to grow considerably in 2011, bringing the overall total to just over $3 trillion absent any new economic downturn or financial market crisis. With either of those two developments, the sky’s the limit.
John Hussman isn’t buying either of the commonly supplied answers for why bond yields are rising – that higher inflation will develop over the near-term or that the U.S. economy has turned the corner and is on the road to a sustained recovery, one that comes without jobs, but with falling home prices. In this week’s commentary he explains:
The key event related to QE2 wasn’t its formal announcement, but was instead the Op-Ed piece that Ben Bernanke published a few days later in the Washington Post, which essentially advanced the argument that the Fed was targeting a “wealth effect” in stocks and other risky assets, in hopes of getting people to consume off of that perceived wealth. At that moment, Bernanke unleashed a speculative bubble in risky assets, and a selloff in safe ones. This has rewarded risk-seeking and punished risk-aversion, but it has also unfortunately driven the markets into an overvalued, overbought, overbullish, rising-yields condition that has historically ended in steep and abrupt losses.
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In short, we are observing what can only be described as a Fed-induced speculative blowoff. While this has been avidly encouraged by the Fed, it is important to recognize that there is no actual economic mechanism at play here other than words. Investors are chasing stocks because Ben Bernanke told them to, and despite the fact that we have seen two plunges of more than 50% each over the past decade, investors are at least temporarily willing to believe that the Fed will “backstop” their risk-taking by preventing the market from falling. As for any “transmission mechanism” attributable to QE2 itself, Treasury yields and mortgage rates have increased sharply since the Fed first announced QE2, and the additional reserves created by Fed purchases have simply added to the already massive and idle pool held by banks. Unless one twists logic into a pretzel so that up is down, one can identify nothing of substance in the Fed’s policy that is supporting the markets. Stocks are being buoyed solely by a combination of words, sentiment and superstition.
There is little doubt that he is correct. The only problem for investors is that there could be a significant upside for financial markets between now and the time everyone realizes that, as we’ve come to learn painfully on multiple occasions in recent years but are quick to forget, the “wealth effect” tends to disappear quite abruptly when you least expect it.
From yesterday’s monthly report on consumer confidence via Reuters and the University of Michigan, it looks as though rising stock prices have done about all they can do to lift the mood of the American consumer, a development that bears only a loose correlation to how much money they spend at the end of the year, goaded into action by retailers.
The consumer confidence index fell for the first time in four months, down from 54.3 in November to 52.5 in December, as job worries are hindering confidence if not consumption, holiday sales seeming to set new records every day. Not surprisingly, after rising over the last year, the percentage of respondents planning to buy a home is back to where it was a year ago, that is, when it looked like the housing rebound was more permanent.
Well, not really. But, the Nobel Prize winning uber-Keynesian economist who regularly extols the virtues of deficit spending at the New York Times does make some very good points about why hyper-inflation has not yet occurred in this item today, points that clearly are not understood by inflation alarmists whose ranks include a good number of elected officials.
The entire post is included below because it is one that will be worth looking back upon in another year or two, perhaps around the middle of the decade (though recent developments would suggest sooner rather than later), to see how much the Federal Reserve bank balance sheet hole-filling morphs into significantly higher levels of money supply and inflation.
Now, keep in mind that, since the Labor Department has been neutering the consumer price index through various measures in recent decades, hyper-inflation is a virtual impossibility, but, the bad news for consumers is that 10 or 20 percent annual inflation as reported in the CPI will feel like hyper-inflation to most people. Anyway, here’s why we’re not yet Wiemar:
Partying Like It’s 1923: Or, The Weimar Temptation
There’s an observation I’ve tried to make in a number of columns and blog posts, but maybe haven’t gotten across as clearly as I should: namely, the extent to which current economic discourse is being warped by what we might call the Weimar Temptation, the desire to see everything in terms of the evils of deficits and the money printed to cover them.
The hyperinflation story is, after all, satisfying both intellectually and morally. A weak, spendthrift government can’t limit its spending to match its revenues; it loses the confidence of investors, so it has to print money to make up the difference; and too much money chasing too few goods leads to ever-higher inflation.
Standard & Poor’s reports(.pdf) that the decline in U.S. home prices is accelerating, both the seasonally adjusted and raw data showing the biggest monthly drop since … March of 2009.
Perhaps more important than the recent monthly changes is the stark new reality that year-over-year home price increases have turned back into price declines for the first time in almost a year, the effects of the expiration of the homebuyers tax credit earlier this year revealing a very weak housing market despite still freakishly low mortgage rates.
The “We’re Not Printing Money” denials from Fed Chief Ben Bernanke are now starting to become tiresome and, in what would probably come as a huge surprise to the detached and myopic bunch at the central bank, these denials are surely not doing much good in bolstering public opinion about the need for the institution that they oversee despite the occasional defense of their practices (such as this) that only seem to push public opinion over to the Ron Paul camp that, for all but the dismal set, makes infinitely more sense.
Of course, common sense isn’t something that economists are overly endowed with and, had the Fed been able to keep asset prices from falling over the last ten years, the public would surely be much more willing to believe anything they say today, but retorts like this in Time Magazine are now doing more harm than good for Bernanke and crew:
Would it be beneficial to the economy if I created new dollars out of thin air whenever I wanted? If it isn’t good for me to do it, why is it good for you and the Fed to create new money at whim? —Jonathan DuPree, MARTINSBURG, W.VA.
The Federal Reserve is buying Treasury securities in order to lower interest rates, which in turn helps people buy houses and cars and promotes investment by firms. That leads to a stronger economy. These policies are not leading to increases in the amount of currency in circulation.
It’s becoming condescending … and the smug photo doesn’t help…
While West Virginia is not known to be a hotbed of cutting edge monetary policy theory, just based on the way the question was phrased, there’s a pretty good chance that Mr. DuPree doesn’t think that the Fed Chief is laboring over a printing press that spews $100 bills.
By Tim Iacono, Since 2005
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