"One fear above all..."
The second paragraph of a recent Economist article starts with these ominous words:
One fear above all stalks the markets: that the rich world’s weapon against economic weakness no longer works. Ever since the crisis of 2007-08, the task of stimulating demand has fallen to central bankers.
The author continues:
Despite central banks’ efforts, recoveries are still weak and inflation is low. Faith in monetary policy is wavering. As often as they inspire confidence, central bankers sow fear. Negative interest rates in Europe and Japan make investors worry about bank earnings, sending share prices lower. Quantitative easing (QE, the printing of money to buy bonds) has led to a build-up of emerging-market debt that is now threatening to unwind... Investors fret that the world economy is being drawn into another downturn, and that policymakers seeking to keep recession at bay have run out of ammunition.
There's no shortage of research and opinion on these various topics. I've sent my contributions to you in email and posted them to Wealth Daily.
But the lurking fear that we will be unarmed when the next crisis must be fought, well, that fear hasn't gotten its due.
There should be no question that the Fed did its job in 2008–9. Cutting interest rates was helpful for addressing the realities of the economic climate, i.e., there was no velocity of money. The real gift that Ben Bernanke's Fed gave the world was a guarantee that assets, loans, and other obligations would be honored by the Fed, if not by anyone else.
Yes, that was absolutely a grand, impossible gesture. There's no way the Fed could have made good on that promise if it had come to that. And obviously, if it had come down to the Fed paying for insurance settlements and payrolls, well, we truly would have already fallen into the abyss that we were staring at.
The Greatest Thing to Fear...
Still, you have to remember what the climate was like in those days. Banks were overwhelmed with mortgage securities (MBSs) and credit default obligations (CDOs) that were becoming worthless. And by worthless, I don't mean they had no value, but that the value was impossible to determine because default rates were soaring and there was no cash to buy them, even if a value could be determined.
That was the root of the issue — if you can't determine a value for the assets, there is no basis to determine the worth of the asset holder. This is the very essence of counterparty risk. And when you have an economy that is dependent on overnight and short-term lending between counterparties, you can see why banks that normally lent to each other freely were suddenly giving each other the hairy eyeball.
This overnight and short-term lending isn't some esoteric thing. If you use your Bank of America ATM card to get cash out of a Citi ATM, Citi is lending Bank of America the money, which Bank of America is then lending to you, until all the accounts can be settled overnight.
But if Citi isn't confident that BofA will settle, well, that's a problem.
I suppose the federal government could have stepped in and given the guarantees that the Fed gave. But it would have been a much more complicated process, in part because it would have been politicized. Someone had to act — and act fast — and the Fed did.
The problem now is how things have played out since then...
What You Get for $3.6 Trillion
I guess we could say it was hubris or some kind of overconfidence. Maybe that's what happens when you save the day like Bernanke and his Fed presidents did.
But interest rates should not have been left at zero for five years. They went to zero as an emergency measure. They should have gone back to 1–2% within two years of the crisis, once the emergency was over.
Instead, the Fed decided to give us $3.6 trillion of bond buying, otherwise known as quantitative easing. Sure, we got a lot of upside for the stock market.
But we also got a shale oil bubble...
And subprime auto loans that are following a predictable trajectory when loan standards are lowered...
And we got an emerging market debt bubble...
All that for $3.6 trillion. And to think, Bernanke could have just cut a $12,126 check for every American man, woman, and child and skipped all the bubble crap...
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THERE'S Your Problem
I don't know why Bernanke decided to do Congress' job. But the Fed can only create the circumstances that are conducive to economic growth. The Fed cannot create demand. And when it tries, it's known as "pushing on a string." Because it's very difficult to move a piece of string by pushing on it. The string tends to get all bunched up, kind of like how the U.S. economy appears now.
Congress is the one that can help create demand. How? It can cut or change regulations and make it easier on small businesses. Small businesses account for half of all existing jobs and two-thirds of new ones. But tax burdens on small businesses are onerous. And small businesses typically can't dodge taxes the way that big corporations can.
If you want to see wages and business spending rise, why not offer some tax breaks or other incentives to small businesses?
And what about better job training? The Department of Labor says there are 5.6 million unfilled jobs in the U.S. right now. That's pretty close to the record set back in July. Many employers complain that applicants don't have the needed skills. That's a problem that can be fixed if Congress really wanted to...
Now, I'm going to say the dirtiest word in America right now: spending. Somehow, we've gotten to the point where you get labeled a commie if you advocate government spending. I get it: people are mad about wasteful government spending. And they voted in people who vowed to cut spending. Mission accomplished: spending is down, and the economy stinks. Great.
Sometimes it's the government's job to spend money to support the American people. Infrastructure would be a good place to start. I'd rather see my tax money go to build some bridges than buy those ridiculous F-35s...
Fiscal and monetary policy are supposed to work together. The Fed has tried too hard, and Congress hasn't really tried at all.
Until next time,
Until next time,
An 18-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He also contributes a weekly column to the Wealth Daily e-letter. To learn more about Briton, click here.
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